Estate Planning Strategies to Make Your IRA Last Longer

Note: This article is an update of the estate planning article in the September 2001 Estate Watch and should be read together.

You now can make your IRA last longer than ever. Thanks to final IRS regulations, account owners over age 70 1/2 are required to take less out of their IRAs or other qualified retirement plans. The new rules allow the owner and beneficiaries to spread distributions over even longer periods than did the proposed regulations issued in 2001. That reduces annual income taxes and allows the IRA to compound into a greater amount. A few other changes that could affect your estate planning also were made in the final regulations.

IRAs and other qualified retirement and estate planning strategies whose owners are older than age 70 1/2 must distribute at least a required minimum amount from their accounts each year. The first distribution must be made by April 1 of the year after you turn age 70 1/2. Subsequent distributions must be taken by Dec. 31 of each year. Beneficiaries of inherited accounts also must take required minimum distributions (RMDs).

To determine the RMD for the first year, take your account balance on Dec. 31 of the preceding year. Then determine the appropriate life expectancy from the IRS tables, and divide that into the account balance. The result is the year’s RMD. The longer the life expectancy is, the lower the RMD. Each subsequent year, you subtract one from the prior year’s life expectancy and divide that into the new account balance to determine the new year’s RMD.

Sweeping proposed rules were issued in January 2001. These rules greatly simplified the methods for the RMD calculation, requiring fewer decisions and lower distributions. Those moves extended the lives of most IRAs. Retirement Watch readers were able to save a lot of money by adapting the methods in the proposed regulations, which were discuss in the March 2001 issue and are available in the Tax Watch archive on the web site. The new final regulations provide additional savings by extending the life expectancy a little less than a year in most cases.

The final regulations made a few other changes from the proposals.

Unlike under the old rules, you don’t have to do your tax and estate planning years in advance and pick the final beneficiary. Now, that can be left to your executor, who can decide which beneficary makes the most sense given your wishes and the tax situation. The designated beneficiary must be one of a group of primary and contingent beneficiaries named by the account owner while still alive.

The beneficiary of the IRA does not have to be selected until Sept. 30 of the year following the year of the account owner’s death (Dec. 31 under the 2001 proposed rules). The first distribution to the beneficiary does not have to be made until Dec. 31 of that year.

An IRA still can be left to multiple beneficiaries. The beneficiaries have two options. The IRA can be maintained as a single IRA, with the age of the oldest beneficiary used to determine the RMD. Or the IRA can be split into separate IRAs for each beneficiary with the RMD determined by each beneficiary’s age.

You can name a trust as an IRA beneficiary and have the beneficiaries of that trust qualify as the IRA beneficiaries for RMD purposes. The regulations, however, list several conditions that must be met for this to be valid. Among those are that the IRA custodian must have information on the trust beneficiaries. Don’t name a trust as an IRA beneficiary unless you have good tax advice.

Beneficiaries who inherited IRAs years ago get a break under the regulations. They can switch to the new rules and basically get a fresh start on their RMDs. This even includes beneficiaries who were required to withdraw the IRA balances within five years of the owner’s death.

The new regulations are mandated beginning in 2003, giving everyone the opportunity for a fresh start. For 2002 you can choose from the January 2001 proposals, the original 1987 proposals, or these final regulations. After 2002, there are three life expectancy tables to consider. The Uniform Lifetime Table will be used by most account owners. The Joint Life Table from the 1987 regulations is used by an account owner whose sole beneficiary is a spouse who is more than 10 years younger than the owner. The Single Life Table is for sole owners of inherited IRAs. The Uniform Lifetime and Single Life tables are available on our web site.

The meltdown of some stocks can be taken into account under the final regulations. If an account balance declined so sharply after Dec. 31 that the remaining balance exceeds the year’s RMD, then the owner can satisfy the RMD rules simply by emptying the IRA.

The final regulations also scale back reporting to the IRS. By 2004, financial institutions will have to report to the IRS who is required to take minimum distributions, but not the amounts of the RMDs.
The penalty for failing to take an RMD is 50% of the amount not distributed. The penalty now applies to inherited Roth IRAs as well as to all traditional IRAs.

Remember that you always can take out more than the RMD. The goal in IRA estate planning usually is to defer distributions for as long as possible and let the tax-deferred compounding work. That’s why you try to select the longest life expectancy for computing the RMD. Not everyone, however, should maximize the tax deferral of an IRA. Sometimes it pays to take more than required from an IRA and empty it early. I covered this in detail in the April 2001 issue, and that article is available in the tax archive section of the web site.