New IRS Rules Simplify Calculations for Retirement-Plan Withdrawals
Though taxpayers won’t benefit this year, recent changes in rules regarding withdrawals from tax-deferred retirement plans will soon make life much less taxing for millions of retired Americans.
The new Internal Revenue Service rules simplify the process of determining minimum distributions from individual retirement accounts, 401(k) plans and other tax-advantaged retirement programs. The changes also could lighten the tax burden for retirees who are making mandatory withdrawals from these accounts.
That’s good news for people such as Wayne and Barbara Priehs, ages 75 and 74, who will be able to reduce their annual IRA withdrawals by 22% this year. That will result in substantial tax savings for the Tucson, Ariz., couple. They also will be able to leave more money in their retirement account to grow tax-deferred.
“This is just super,” Wayne Priehs said. “This will allow us to keep more of our principal saved in case we need it later on.”
The new rules are considerably easier than the byzantine regulations they replace. But as is usually the case with tax law, “easier” doesn’t mean “easy.” Figuring out when and to whom the new rules apply and how to calculate the appropriate IRA withdrawal is still a bit complicated and may, in part, depend on the type of retirement plan you hold.
Here’s some guidance:
* The issue: In most cases, government rules require retirees who have reached 70 1/2 to start withdrawing money from their tax-deferred retirement accounts. The aim is to collect income tax on this previously untaxed money before the account holders die.
In general, retirees must start making withdrawals by April of the year following the year in which they turn 70 1/2. The minimum withdrawal is based on a regulatory formula.
Until the IRS revamped its rules in January, there were eight possible withdrawal formulas, each with a different set of complex repercussions. Once retirees chose a formula, the decision was irrevocable. If they made a bad choice, they were stuck with it for life.
Worse still, the choices were so complicated that many retirees had trouble calculating the distributions correctly. Retirees who didn’t withdraw the required amount--there’s no penalty for taking out more than the minimum--faced fines equal to the shortfall in the withdrawal.
The only good news was that the IRS didn’t have an effective way of knowing whether correct withdrawals were being made.
* What the new rules do: The eight distribution choices are reduced to two categories: one for people who have spouse-beneficiaries who are more than 10 years younger than they are, and one for everybody else.
They also give participants in IRAs and 401(k) and 403(b) plans a second chance by allowing them to use the new formula, regardless of which one they chose in the past.
* How to calculate a minimum mandatory distribution: To calculate mandatory distributions, retirees need to answer two questions: Is their spouse going to be the beneficiary of the IRA? If so, is he or she more than 10 years younger than the account holder?
If the answer to both questions is yes, retirees should determine their minimum mandatory withdrawal amounts by using their actual ages and the formula set out in IRS Publication 590. (A copy of this publication can be printed or downloaded from the IRS Web site at https://www.irs .gov.) Under this scenario, the mandatory distribution formula shouldn’t change from what it was.
However, if the answer to either question is no, retirees can use the chart accompanying this report to figure their mandatory distribution. Account holders should divide the most recent year-end balance of their IRA by the divisor in the chart that corresponds to their age.
In other words, someone who is 75 and has $100,000 in an IRA at the end of 2000 should divide $100,000 by 21.8. The result: At least $4,587.16 must be withdrawn from the account in 2001.
* Impact on beneficiaries: The old rules had lots of traps for beneficiaries.
In one 1999 case, two Los Angeles sisters inherited a sizable IRA from their father. However, their father hadn’t named them as the primary beneficiaries of the account, and the primary beneficiary had died. The sisters were required to withdraw all of the money from the IRA within one year--exposing them to a huge tax bill.
Under the new rules, in cases where there is no primary beneficiary, a new one can now be named after the account holder’s death. The new rules also make it easier for a primary beneficiary to withdraw the money gradually rather than all at once--allowing much smaller annual distributions, longer tax-deferred growth and much more reasonable income tax payments.
Unfortunately, taxpayers can’t apply the new rules to an old distribution, said Martin Nissenbaum, national director of personal income-tax planning at Ernst & Young in New York. Once IRA money has been out of a tax-deferred plan for 60 days, it’s considered distributed and taxed.
* Effective dates: The new rules are retroactive to Jan. 1, 2001, but they do not apply to 2000 distributions, according to the IRS. (2000 withdrawals can be taken any time before April 1, 2001.)
There’s one caveat. In the case of qualified plans, such as a 401(k), the plan administrator will decide when the plan will begin to adhere to the new rules, Nissenbaum said. Theoretically, plans could stall until the rules are finalized, or at least until the comment period is over late this summer.
On the bright side, once plans do start applying the new rules, they will calculate minimum required distributions for account holders and notify them of the amount they’re supposed to withdraw. This calculation and notification requirement, also part of the new rules, is designed to help the IRS make sure taxpayers comply.
Those with more than one account will get notices of minimum required withdrawals from each account sponsor. The total required distribution is the sum of all the minimum distribution figures in the notices.
Withdrawals can be made either by taking part of the distribution from each account or all of it from one account, leaving the others untouched. The IRS cares only that the total required amount is withdrawn--and taxed.
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New Distribution Rules
To determine the required minimum yearly distribution from a retirement account under the new rules, divide the balance of the account at the end of the previous year by the figure next to the account holder’s age.
Example: A 75-year-old with $100,000 in an IRA at the end of 2000 would divide $100,000 by 21.8. The minimum required withdrawal in 2001 is $4,587.16.
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Age Divisor 70 26.2 71 25.3 72 24.4 73 23.5 74 22.7 75 21.8 76 20.9 77 20.1 78 19.2 79 18.4 80 17.6 81 16.8 82 16.0 83 15.3 84 14.5 85 13.8 86 13.1 87 12.4 88 11.8 89 11.1 90 10.5 91 9.9 92 9.4 93 8.8 94 8.3 95 7.8 96 7.3 97 6.9 98 6.5 99 6.1 100 5.7
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Source: Internal Revenue Service
