Originally created 02/05/01

IRA and 401(k) rules have changed

You'd better be sitting down when you read this.

In January, the Internal Revenue Service made life easier for people with Individual Retirement Accounts, 401(k) plans and some other retirement programs.

The agency we all love to hate, especially this time of year, proposed new rules for figuring the minimum amount you have to take out of your retirement accounts and for naming beneficiaries. You must start drawing those amounts by April 1 of the year after you turn 70 12 or face stiff financial penalties.

Why make you take a minimum amount out of those plans?

Well, you haven't paid federal income taxes on the amounts you contributed over the years or the earnings that built up on those contributions.

The government "doesn't want you to defer (income taxes) on these accounts forever because they were intended to be used for retirement income, not a tax shelter," said Nicholas Kaster, senior pension law analyst at CCH Inc., a provider of pension, tax and human resources law information in Riverwoods, Ill.

Although the new regulations won't be official until Jan. 1, 2002, you may use them now, Kaster said.

If you have started or are about to start taking those minimum payments, you should strongly consider switching from the 1987 rules to the new formula, he and other advisers said.

"I can't think of a circumstance where you would be better off using the 1987 regulations," Kaster said.

Under the old rules, you had several options, based on your life expectancy and the life expectancy of your beneficiary, to decide the minimum amount you needed to take each year from your retirement accounts.

The new regulation has only one option for most people - the formula that under the old rules gave you the smallest possible minimum withdrawal, said Theresa Fry, retirement planning specialist at A.G. Edwards & Sons Inc. in St. Louis. "For most people it means a reduced (required minimum) distribution."

To do the calculation, all you need to know is your age, she said.

Say you are 70 years old. Under the new rules, your distribution period would be 26.2 years - your life expectancy at that age. To figure your minimum distribution, you divide the amount of money in your retirement accounts at the end of the previous year by the distribution period.

For example, you had $100,000 in an IRA on Dec. 31. The minimum you must withdraw this year to avoid the penalty would be $3,817.

If your wife or husband is more than 10 years younger than you are and is your account beneficiary, you get an even better break with the new rules, Kaster said.

You may use a table matching your age with his or her age and come out with a lower minimum distribution than with the new standard chart, Kaster said. You can't use that table for any beneficiary other than a spouse, though, he said.

Some people need to take more than the minimum amount from the IRAs and retirement plans to meet their cash needs. The new calculations won't affect them.

"A lot of retired people don't need this money and would prefer it to grow," said W. Warren Smith of AmSouth Investment Services Group in Memphis.

They will benefit from the new rules, he said.

"The smaller amount you're required to take out, the less income tax you're going to pay every year and the more you're going to be able to accumulate in those accounts," Fry said. "That will be good for your beneficiaries."

And, the new rules make choosing a beneficiary more flexible than the 1987 regulations, which affect people who take more than the minimum amounts required as well as those who don't.

To use a beneficiary for your life expectancy calculations under the old rules, you had to name someone before you started taking distributions, Fry said. You were stuck with that calculation forever, even if you changed beneficiaries.

With the new regulations, it doesn't matter when you name a beneficiary or how often you change because it doesn't affect the minimum distribution calculation. Your IRA or other account will go to the beneficiary of record on Dec. 31 of the year after you die.

This will help your heirs, Smith said.

For one thing, the old rules didn't allow your heirs to roll your IRAs into their own IRAs if you had started taking distributions from your account. In some cases, that meant the IRA had to be paid in a lump sum to your beneficiaries after you died.

Under the new rules, your IRA money may be put in separate accounts owned by your beneficiaries in the year following your death, she said. Then the money would be paid out to them based on their life expectancies.

That would reduce or at least postpone the income tax burden on your heirs and allow the IRA fund to build up earnings, tax deferred, for their use later.

The new rules may have some estate tax consequences.

If you use the new chart to reduce the minimum amount you take out each year from your IRA, it is likely more will be left in the account when you die than if you had used the 1987 schedule.

Even if your IRA money is parceled out to heirs after your death, the fair market value of your account when you die is considered part of your estate for estate tax purposes, she said.

That could mean higher taxes on your estate than under the old minimum distribution rules. You need to review and update your estate plan to take that into account.


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