IRS Simplifies Rules for Withdrawing
Tax-Deferred Funds
In a surprise move, the Internal Revenue Service has
dramatically simplified distribution rules for tax-deferred
retirement plans, allowing retirees to take less money out of their
accounts each year--and
pay less income tax in the process.
The proposed changes
affect the millions of Americans who contribute to any of several
types of tax-favored retirement plans, including individual
retirement accounts, 401(k) plans, 403(b) plans, and 457 plans, as
well as millions of future retirees and their heirs. Though subject
to public comment, the changes went into effect retroactively at the
beginning of this month.
“These [changes] caught everybody
out of the blue,” said Stephen J. Silverberg, president of the
Pension Council of Long Island and managing partner of Silverberg
& Hunter in Garden City, N.Y. “It is really a good and
significant change. It benefits almost everybody.”
The rules
create a simple formula for calculating a retiree’s minimum
distribution amount, replacing amore complicate
system.
Previously, people with tax-deferred retirement plans
such as IRAs and 401(k)s had to make an irrevocable “election” by
April in the year after they turned 70˝. That decision determined
how quickly they had to deplete the money in those retirement
plans.
The
old minimum distribution rules offered eight choices and little
guidance as to which was the best choice for a given retiree.
And once an election was made, a retiree was stuck with it forever,
even if it meant taking more money out of the retirement plan each
year than was needed. Not only would that mean paying
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income
tax, but it would also leave less money in the account to grow
tax-deferred.
Moreover, if an account holder died without
making proper beneficiary elections, heirs could be forced to
deplete the account almost immediately, often paying income tax at
the highest marginal rates.
The new rules eliminate these
problems. Not only do they make it easier to figure out how much
needs to be withdrawn from a retirement account each year, they also
allow current retirees to go back now and make changes in their
withdrawal schedule.
Beneficiary designations also can be
made posthumously--up
to Dec. 31st in the year after the account owner’s
death--thanks
to these revised regulations.
Here is how the new rules work
and how they affect retirement-account owners.
Q Why are the changes
important?
A At age 70˝, owners of IRAs,
401(k)s and other tax-deferred retirement accounts have to start
withdrawing money from the accounts and pay the deferred income tax
on the amount they withdraw. The reason: The IRS wants to collect
the deferred tax before the account owner dies.
However, many
retirees want to minimize the amount hey withdraw from their
tax-deferred accounts to avoid paying income tax on money they don’t
need.
The previous rules gave taxpayers eight choices to
figure their required distribution. The formulas were complicated,
and each resulted in a different annual amount.
The
new rules simplify matters by letting retirees use the formula that
allows the least amount of money
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to
be withdrawn from an account each year--resulting in the lowest tax
bill.
Retirees can calculate the withdrawal amount by
using an age-related divisor provided by the IRS (See accompanying
chart).
There is an exception: If a spouse is the IRA
beneficiary and that spouse is more than 10 years younger than the
IRA account owner, the distribution formula would be based on the
actual ages of the account holder and the beneficiary. That allows
such couples to stretch out distributions over the longest possible
period.
Q What
if someone wants to take out more money than the formula
requires?
A That’s
always allowable. The IRS restricts you only from taking out
less.
Q Don’t
these “proposed” rules have to be finalized before they go into
effect?
A No.
The rules on retirement-plan distributions that taxpayers have been
following for 26 years have never been finalized. This new proposal
is a revision of those past, proposed rules, all of which were
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treated as the law of the land from
the moment they were published.
Q Why would the IRS do this if it
meant that everyone can pay less tax?
A Under the old rules, no one
knew precisely how much any given retiree should be taking out of
his or her retirement account. Retirees had to figure it out
themselves and compliance was on the honor system.
Under the
new rules, retirement-plan trustees must calculate the minimum
required distribution for account holders and then report that
amount to the IRS, making it much easier for the agency to track
compliance.
Q What
happens to beneficiaries when an account owner dies? Do they have to
withdraw all the money from the account
immediately?
A Assuming the beneficiary is
valid, he or she can now take withdrawals from the retirement
account over time. If an IRA is left to a spouse, for example, he or
she would be able to roll it into a new IRA, name a new
beneficiary--such
as a friend or a child--and
then start making withdrawals based on the new minimum distribution
tables. |