Beat the Tax Man
IRA distribution rules have changed. Understanding the IRS’ new “stretch” regulations can help you turn your IRA into a family legacy.
By former Army Capt. Phil Dyer, CFP, Deputy Director, Benefits Information

Until recently, non-spouse IRA beneficiaries, such as children and grandchildren, faced rapid depletion of IRA assets because of IRS regulations. These rules required either a five-year payout, if the IRA owner died before his or her required beginning date (RBD), or a payout using the owner’s life expectancy, if the IRA owner died after the RBD.

New rules went into effect in 2002 simplifying IRA distributions for non-spouse beneficiaries and allowing IRA owners to “stretch” payments over the life expectancy of children, grandchildren, and even great-grandchildren with proper beneficiary designations. The IRS now uses a unified table for non-spouse beneficiaries, annually published in IRS Publication 590.

There are two key terms to understanding how the new distribution rules work:

• Required Beginning Date (RBD): IRA distributions must begin by April 1 of the year after an IRA owner turns 70-1/2 years old; this is the RBD. Most advisors, however, recommend taking the first distribution in the year you turn 70-1/2. Otherwise you will need to take two distributions — one by April 1 and another by Dec. 31.

• Required Minimum Distribution (RMD): This is the minimum amount required by law to be withdrawn from the IRA. The RMD is determined by dividing the balance of the IRA, as of Dec. 31 of the previous year, by the current life expectancy of the IRA owner (if alive) or the life expectancy of the beneficiary (if the original IRA owner is deceased). Failure to withdraw the RMD results in a hefty 50-percent excise tax on the amount not withdrawn.

For example, Jim (age 76) has an IRA worth $750,000 and has been taking RMDs since age 70-1/2. His wife, Sally (age 67), son Albert (age 40), and granddaughter Meg (age 14) all are equal beneficiaries. If Jim dies July 4, 2005, his executor has until Sept. 30, 2006, to subdivide the IRA into three segregated accounts.

Sally isn’t 70-1/2, so she can use a special spouse-only rule to roll her portion into an IRA in her name and defer RMDs until she reaches her RBD. Because Albert and Meg are non-spouse beneficiaries, they must take RMDs according to their life expectancies as stated by IRS Publication 590.

At age 40, Albert’s life expectancy is 43.6 years. By dividing Albert’s portion of his father’s IRA balance of $250,000 by 43.6, he yields a first-year RMD of $5,734. Assuming a 6-percent annual return on the account, earnings will be $15,000 — growth of $9,266. Meg is in better shape, because at age 14, her life expectancy is 68.9 years. Her first-year RMD is only $3,628, but with a 6-percent growth rate, her portion will increase by more than $11,000, even after the RMD. With proper planning your heirs can enjoy years of low RMDs and increasing account balances.