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New
distribution rules regarding retirement
Mar. 15, 2001 - Just
remember you heard it here first – THE IRS DID SOMETHING
TO MAKE YOUR LIFE EASIER!
And
if your age is 70 ½ years or older – or know someone who
is -- you’re going to be really interested. You know how
you’ve been putting all those pre-tax dollars into a
retirement plan? Well, the IRS has changed the rules that
govern the disbursement of your IRA, 401K or other
qualified, non-IRA pension plan that can make your
retirement nest egg go farther.
“It
was a huge mess before – it was so complex,” says
Millian. “The new regulations are over 100 pages, but
they’re so user-friendly -- the explanation is only 26
pages.”
And
while the rules aren’t mandatory until January 1, 2002, if
you’ve over 70 ½ years, you’d be crazy not to take
advantage of them now. If it is a non-IRA plan, the key is
making sure the custodian of your plan makes the necessary
amendments in time – but we’ll get to that in a minute.
For
now, the best way to explain how the IRS rules have changed,
is a before and after look at how they affect the average
retirement plan participant based on age.
Ages
59 years and under
The
rules do not affect this age group. You cannot withdraw
money from your plan before the age of 59 ½ without paying
a 10 % penalty tax on the distribution, on top of your usual
income taxes. “There are five exceptions to that such as a
medical emergency,” Millian says, “but those exceptions
are very strict.”
These
rules have not changed.
Ages
59 ½ to 70 years
Once
you turn 59 ½ years, you don’t have to withdraw any
funds, but the IRS will allow you to start taking
disbursements from your plan without any penalty, but you
still have to pay income tax. “At this age, if you don’t
need the money to live on, good tax planning calls for you
to leave it in the plan as long as possible,” Millian
says. “So you want to take out as little as possible,
because once you do, you’ll start paying taxes on it and
you don’t want to do that until you’re older and in a
lower tax bracket.
Ages
70 ½ and over
This
is the group of people who will be most affected by the new
rules because once you turn 70 ½ years of age, the IRS
requires you to start taking distributions from your
retirement plan. They also set the minimum amount you must
take out each year based on their chart of your life
expectancy. The shorter your life expectancy, the more you
have to take out.
“The
IRS forces you to start taking distributions at this age
because your plan was set up as a retirement account and the
tax is deferred until your retirement,” Millian says.
“If you were to die before you drew out your pension, it
could pass on to your beneficiary or estate without tax ever
being paid on that income.”
Basically,
IRS wants you to have to pay tax on it at some point and
forcing you to take your pension guarantees them they’ll
get their taxes from you. And the greater the amount of
money you draw, the higher the tax bracket you’ll be in
– thus paying a higher percentage in taxes as well.
But
here’s where the new rules will help you. You still have
to start taking distributions from your retirement plan once
you reach 70 ½, but the IRS has reduced the minimum amount
you have to take out. The rules also stretch out the length
of time you have to draw it. “If you used to have to take
it all out over the course of 20 years, for instance, now
you might have 25 years to draw it,” Millian says.
“Essentially, you can take out less over a longer period
of time.”
Beneficiaries
benefit too
The
IRS also changed the rules that relate to how your
retirement fund disbursements are to be handled and taxed if
you die and pass them on to a beneficiary. “If the
beneficiary is anyone other than your spouse, they would
have had to
take distribution within five years of inheriting it and
then pay regular income taxes on it,” she says,
“because, generally speaking, income in the hands of a
beneficiary is taxed the same way it would have been taxed
to the decedent.”
But
now that 5-year rule is gone. While you could take all the
money from the plan now, you don’t have to. “Now, the
inherited funds in effect becomes a pension plan for the
beneficiary and the rules treat it as such.”
You
can either take the distribution now and pay taxes on it or
save it until you retire.”
Getting
the advantage now
“It
is must for a qualified plan (not an IRA) to be amended with
these changes before these new rules can be used,” Millian
says. “So employers who have plans have to amend them
before participants can take advantage of them.”
The
IRS requires all plan providers to make the amendments by
Jan. 1, 2002, but it’s optional for them to make the
amendments now. “If they do the optional changes now,
it’s a lower minimum distribution and therefore less tax
for the participant to pay.”
There’s
only one person who can’t benefit from the changes this
year. “That is someone who turned 70 ½ in 2000 and who
elected payout beginning April 1, 2001. That person must use
the current tables because it is 2000 benefits being paid in
2001. But next year, they can take advantage of the new
minimums.”
Otherwise,
you only have to look to the new tables now to find out the
minimum amount you must withdraw in order to reap the
benefits of the new rules this year.
“The
problem is, most plan custodians aren’t even aware of
these changes because they’re so new,” Millian says.
“The people at the bank who oversee the plans get the
information from the top and if it doesn’t filter down,
they’re not going to make the new tables available in time
for you to benefit from it this year.”
Millian M. Toms
is a Royal Oak-based CPA and business advisor. She is also an active
member of the community including The Optimists and Greater Royal
Oak Chamber of Commerce.
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