GRAND RAPIDS — The U.S. Internal Revenue Service has decided to make life and estate planning somewhat more flexible for a great many people who hold individual retirement accounts and much more favorable to their beneficiaries.
According to a recent announcement from Robert M. Zalokar of Salomon Smith Barney Inc. in Grand Rapids, the IRS has done “a complete about-face” by announcing some new regulations concerning the distribution of IRAs.
Zalokar, vice president-investments at the firm’s offices at 99 Monroe Ave., told the Business Journal new regulations have three positive impacts for taxpayers:
- In most cases, they lower the size of Required Minimum Distributions (RMD) which become mandatory at age 70 1/2.
- They now allow IRA owners to change beneficiaries at will because, except for spouses, beneficiary designations no longer are a factor in calculating RMD.
- They now allow anyone inheriting an IRA to receive payments from it over his or her lifetime, or to keep the IRA intact until their own retirement years.
Previously only a surviving spousal beneficiary had such options. For a youthful beneficiary, being able to “let an inherited IRA ride” could mean enormous growth in the account by his or her retirement.
Prior to this change, a non-spousal beneficiary had a maximum of five years in which to take distribution of an IRA, a provision which — depending on the IRA’s size — could put the beneficiary in a difficult tax situation.
Being able to distribute an IRA in, say, 15 or 20 annual increments would substantially ease the annual tax bite.
In referring to the first change, Zalokar said lowering the size of RMD means the account’s owner can keep more funds tax-deferred so that he or she can report less taxable income.
“This may have a positive ripple effect on the taxability of any Social Security benefits you are receiving, the phase-out of personal exemptions, and other tax issues,” he indicated.
He also said the new RMD calculation is far simpler than was the case with requirements that have been in effect since 1987.
“Under the new IRS rules,” Zaloker advised, “you no longer have to designate a beneficiary prior to taking your first required minimum distribution.” As for the recalculation, term certain and hybrid methods of RMD calculation, he said to forget them; they are obsolete.
“You need only to determine two numbers in order to calculate your required minimum distribution: the fair market value of your IRA as of the prior year-end, and the life-expectancy factor associated with your age.
“With very limited exceptions, all IRA owners over age 70 1/2 will use the Uniform Life Expectancy Table — formerly called the MDIB Table — to determine their life expectancy factors.”
Under the old IRS rules, he added, IRS holders were locked into their beneficiary when calculating RMD. But using the Uniform Life Expectancy Table in most cases makes beneficiary selections irrelevant in RMD calculations.
He cited one exception: the instance where the IRA owner changes beneficiaries to a spouse who is more than 10 years younger than the IRA owner.
In that case, the IRA owner employs the Joint Life Expectancy Table to calculate RMD, which will reduce annual distributions even further.
If the IRA owner changes to a spouse beneficiary who is less than 10 years younger, then the Uniform Life Expectancy Table applies.
The new regulations also give beneficiaries greater flexibility if they inherit an IRA.
He said that while spouse beneficiaries always have had the option of continuing to use an IRA as their own to shelter inherited IRA assets, IRS regulations limited the choices of beneficiaries who were not widows or widowers. In most cases, the beneficiary had to take distribution of the IRA over a maximum of five years, and pay the deferred tax on the funds as they were received.
Now, however, any IRA beneficiary may keep an IRA inheritance on a tax-deferred basis by establishing so-called conduit or beneficiary IRA.
“This feature can be especially attractive to younger non-spouse beneficiaries,” Zaloker advised, indicating those beneficiaries now will be able to calculate distributions based on their own life expectancies, which could extend the life of this IRA into their own retirement years.”
Zaloker also advised that the new regulations — even though they will not be finalized until 2002 — apply immediately and universally to IRA owners who are taking distribution using the obsolete methods of calculating distributions. “IRA owners taking required minimum distributions for calendar year 2001 may calculate their distributions under these new rules.
“The IRS,” Zaloker added, “has indicated that if the final rules are more restrictive, they will not be made retroactive to 2001 distributions.”