Planning for Individual Retirement Accounts
Goldberg, Seymour, Journal of Accountancy
Many taxpayers default into IRA distribution methods that prove disastrous for surviving family members.
Taxpayers throughout the United States have accumulated considerable wealth in qualified retirement plans. At retirement, they generally will take lump-sum distributions from their plans and roll them over into individual retirement accounts. Proper planning will ensure continuation of IRA benefits to family members long after the IRA owners and their beneficiaries have died.
Many taxpayers default into IRA distribution methods that initially appear worthwhile but later prove disastrous to surviving family members if both IRA owners and their beneficiaries die in their 70s. This article describes available IRA distribution options to help taxpayers and their advisers make appropriate distribution elections.
MINIMUM DISTRIBUTION RULES
IRA distributions generally are subject to the required minimum distribution rules in Internal Revenue Code section 401(a)(9). On July 27, 1987, the Internal Revenue Service issued comprehensive proposed regulations for IRA minimum distribution requirements and required minimum distribution rules from other retirement arrangements.
A taxpayer must begin to receive distributions from an IRA on or before his or her required beginning date April 1 following the calendar year in which he or she reaches age 70 1/2. For example, if George Smith, an IRA owner, was born on February 1, 1923, he will reach 70 1/2 on August 1, 1993, and must begin receiving IRA distributions by April 1, 1994. Smith may take a required minimum distribution for calendar year 1993 either during 1993 or take it no later than April 1, 1994. The calendar year in which Smith becomes 70 1/2 is called his "first distribution calendar year."
Smith is permitted to postpone the first calendar year's distribution in whole or in part until the following April 1. Tax planning will dictate whether the deferral option-which is not available for any succeeding distribution calendar years--should be used. Thus, Smith's IRA distribution for 1994 must be made by December 31, 1994.
If a taxpayer fails to receive a timely required IRA distribution, he or she is subject to an excise tax of 50% of the distribution shortfall. If Smith, for example, is required to receive a required minimum distribution for calendar year 1994 of $50,000 and only receives $30,000, the excise tax liability for 1994 is 50% of the $20,000 shortfall, or $10,000. The IRS may waive the excise tax if the taxpayer's failure to receive a required minimum distribution was due to reasonable error that the taxpayer takes steps to correct. A reasonable error might occur if a taxpayer retains a pension consultant and receives inappropriate advice. Distributions from other retirement arrangements also are subject to an excise tax.
It is important for CPAs to master some of the technical aspects of the 1987 proposed regulations regarding IRA distributions. Appropriate planning may result in substantial savings.
Many taxpayers are unaware of the distribution options they can elect to satisfy the required minimum distribution rules.
The proposed regulations under section 1.401(a)(9)-1, Q&A E-7 are extensive and may be difficult to explain to a client. However, the IRA owner must make a key decision no later than his or her required beginning date, choosing to elect a fixed number of years for IRA distributions or to elect the life-expectancy recalculation method (the IRA owner's life expectancy expands each year).
Most IRA agreements permit the taxpayer to opt in or out of the life-expectancy recalculation method. Once an election is made, it is irrevocable and applies to all subsequent years. The election should be made in writing and given to the IRA custodian no later than the IRA owner's required beginning date.
If the IRA owner is permitted to elect either the term-certain or life-expectancy recalculation methods and fails to do so, the recalculation method is the default option unless the IRA agreement provides otherwise. …