03 Apr What do IRA Retirement Planning and A Retirement Symphony Have In Common?
Writing a Retirement Plan just like a Retirement Symphony is certainly a lot of hard work. The composer must pay attention to every detail and be methodical about ensuring that all the instrumental sounds blend together. Some composers may spend years, or even a lifetime, to achieve their “masterpiece.” And, most of them will tell you that, quite often, the toughest part of writing music is actually finishing the composition. They’ll go on to say that the personal rewards of completing their symphony far outweigh the hard work and perseverance that was necessary for completion.
In many respects, retirement planning is a lot like composing a symphony. You can spend your entire working-life building a nest egg. Then, in the end, your pension, profit-sharing, or 401(k) plan will, more than likely, be consolidated into an Individual Retirement Account (IRA). In order for retirement to bring music to your ears, you’ll need to make sure that you have a basic understanding of some important tax rules facing IRAs.
Playing Uncle Sam’s Melody
Current rules mandate that you must begin taking minimum distributions from your IRA by April 1st of the year after reaching age 70½ (however, employer-sponsored qualified plan distributions can be postponed until retirement if you continue working past age 70½ and are not an owner-employee).
Although the first required distribution is actually for the year in which you attain age 70½—the Internal Revenue Service (IRS) merely lets you postpone it until April 1st of the following year. If you do postpone the first distribution, a second distribution would be due by December 31st for the current year, substantially increasing taxable income for that year.
The IRS uses life expectancy figures to determine the required minimum distributions (RMDs) IRA holders age 70½ and older must receive. A life expectancy figure approximates the distribution period—the estimated length of time an individual will take withdrawals from his or her IRA. Population trends indicate that people are living longer and, thus, may need income for an extended period of time. In response, the IRS has increased life expectancy figures and, as a result, the mandatory withdrawal amounts have decreased. The reduced requirements may afford people the opportunity to keep their savings tax-sheltered for a longer period of time. It is important to note that an account holder may withdraw more than the minimum, but failure to take the required withdrawals results in a 50% tax penalty on the shortfall.
For most, minimum distributions may now be calculated according to one uniform table based on the joint life expectancy of the taxpayer and a hypothetical beneficiary who is ten years younger, even if no beneficiary is named. If the designated beneficiary is a spouse who is more than ten years younger than the owner, a separate, generally more favorable, table (joint life and last survivor expectancy) is used. In the event that a person has more than one IRA, the minimum distributions must be calculated separately for each IRA, because different multiples (i.e., life expectancies) may apply to each IRA. The sum of the separate minimum distributions is the total IRA amount that must be withdrawn for the year. However, this amount can be taken out of any one or more IRA accounts.
To calculate the amount of a required distribution, divide the IRA balance (as of December 31st of the previous year) by the applicable distribution period. For example, a person age 75 with an IRA valued at $100,000 would have an annual RMD of $4,587, based on a distribution period of 21.8 years. Before the legislative changes, a person age 75 with an IRA valued at $100,000 would have had an annual RMD of $8,000, based on a distribution period of 12.5 years. For each subsequent year, the required minimum distribution must be recalculated.
Making the Most of Your Orchestra
The recent legislative changes also provide greater flexibility for an IRA holder to change beneficiaries. Account holders who have begun receiving payouts may postpone the designation of one or more beneficiaries or change beneficiaries.
Furthermore, primary beneficiaries may refuse or “disclaim” the account, allowing it to pass to a contingent beneficiary, who can then receive distributions based on his or her life expectancy. The lower tax liability on the smaller distribution and the continuation of tax-deferred growth also pass on to the named contingent beneficiary. This change will be welcomed, for example, by couples who want to ensure that IRA assets are available to surviving spouses, who, if financially secure, could then disclaim the amounts and pass them on to children or grandchildren.
Whether you are about to retire, or just doing a little retirement daydreaming, there are intricate rules that will require you to make some important decisions. However, by collaborating with qualified tax, legal, and financial professionals, you can take a big step in helping to ensure that your symphony is not left “unfinished.”