Hatching a Bigger Nest Egg – Part II

Why it pays to plan IRA distributions

If you have sufficient income from other sources, you may wish to forgo taking distributions from your Traditional IRA or employer-sponsored retirement plan as long as possible. This can delay income tax and increase the amount you leave your heirs.

Tax law, however, mandates minimum withdrawals after age 701/2 for most plans including the Traditional IRA. But by planning ahead, you can preserve your retirement account balance, minimize income taxes, and live the retirement you’ve always dreamed.

Calculate Required Distributions Early

Under rules adopted in 2002, nearly all retirement plan participants now calculate their required minimum distribution (RMD) by reference to the same IRS table. This table specifies what amount must be distributed annually based on the plan’s previous year-end value and the number of years you and your beneficiary are likely to live.

You could possibly lower that amount. The table automatically assumes that your beneficiary is 10 years younger than you, but if your spouse is the sole beneficiary and is more than 10 years younger, you can use his or her actual age — resulting in a lower RMD.

Required distributions normally must begin when you reach age 701/2. If you decide to postpone distributions for one more tax year, you must double up the following year, taking the first year’s distribution by April 1, and the second by Dec. 31. Doubling up, however, may not be a good idea if it could push you into a higher tax bracket or cause you to be subject to deduction limits that apply based on adjusted gross income.

If you fail to take your RMD, the IRS can impose a penalty of 50% of the shortfall — or the difference between the amount, if any, you took and the amount you should have taken. That penalty, however, may be waived if the error was due to “reasonable cause”: for example, your advisor provided you with incorrect information, and you are taking steps to remedy the error.

Note: RMD rules don’t apply to Roth IRAs. In fact, you are not required to take any Roth IRA distributions during your lifetime. And while qualified plan accounts are generally subject to the same RMD rules as IRAs, you can delay distributions if you are still employed by the plan sponsor and don’t own more than 5% of the company sponsoring the plan.

Understand Post-Death Distributions to Maximize Benefits

Rules for distributions on inherited IRAs changed quite significantly recently, so be sure to understand how the changes affect you. Generally, your non-spouse beneficiaries may take distributions over their lifetimes, regardless of whether you began taking distributions during your lifetime. To do so, however, they must begin taking distributions no later than the end of the year following your death. If they miss the deadline, they’ll be required to withdraw the entire amount no later than the December 31st of the fifth year following your death.

It may make sense to leave some or all of your retirement plans directly, or through certain types of trusts, to children or grandchildren. Because such decisions involve income tax and estate tax issues, it is important to seek advice that considers your overall estate planning objectives.

If your beneficiary is your spouse, distributions don’t have to begin until you would have reached age 701/2. Or your spouse can roll over your retirement plan into his or her own IRA and take distributions accordingly. You’ll probably want to look at which alternative will allow distributions to be spread out the most.

Take Advantage of the Rules

Assuming the funds aren’t needed sooner, taking maximum advantage of these rules can spread out and substantially delay income taxes on distributions. This may allow you to grow more tax-deferred and leave a greater amount to your loved ones.

Disclaimer: Equity Trust is a passive custodian and does not provide tax, legal, or investment advice. It does not endorse or recommend any contributor, company, or specific investments. Any information communicated by Equity Trust Company is for educational purposes only and should not be construed as tax, legal, or investment advice. Whenever making an investment decision, please consult with your legal, tax, and accounting professionals.