You may have a traditional or rollover IRA or other retirement accounts. The funds that are held inside these retirement accounts have not been taxed and grow (hopefully) income tax free. You are taxed on the retirement funds only when you withdraw them from your retirement account. There are rules about how much and when you can take distributions out of these accounts.
You do not want to take a distribution too early. If you take a distribution out of your retirement account prior to age 59½, you may be subject to the early withdrawal penalty tax of 10%. You can avoid the early withdrawal penalty in certain circumstances such as if you take distributions out in substantially equal payments over your lifetime or pursuant to certain divorce orders or to pay for certain educational, medical or first time home buyer expenses.
You do not want to take a distribution too late. Distributions from retirement accounts must begin no later than April 1 following the calendar year you reach age 70½. For employer plans and if you are not at least a 5% owner, you can wait until you retire if it is later. If you do not take your required minimum distribution in any given year, you are subject to an excise tax of 50% of the shortfall.
You do not want to take too little of a distribution. When you reach your required beginning date of age 70½, you must use the IRS published Uniform Lifetime Table to determine your distribution unless your spouse is more than 10 years younger than you and is named as your sole beneficiary. In that case, you use the Joint and Last Survivor Table.
To determine the required minimum distribution that you must withdraw by December 31 of each year, you just simply divide your account balance as of December 31 of the previous year by the divisor provided on the chart. This process continues annually until your death.
Upon your death, if your surviving spouse is named as your beneficiary of your retirement plan account, he or she can generally roll over the balance of your retirement account into their own rollover IRA and then take distributions after age 70½ over their lifetime.
You may name individuals other than your spouse such as children or grandchildren as beneficiaries of your retirement account. They could also receive their share over their lifetime as set forth in the IRS published Single Life Table so long as distributions start within one year of your death. Your surviving spouse also has this option.
To determine your beneficiary’s required minimum distribution, the balance of your retirement plan account on the previous December 31 is divided by the divisor on the chart for the age of your beneficiary at the time of your death. Each year thereafter, they just reduce by one, the number of the divisor to determine the annual distribution. With this option, if you had already started receiving required minimum distributions during your lifetime, your beneficiary could use your published life expectancy if it is longer than their own.
The Federal government through the Worker, Retiree and Employer Recovery Act of 2008 has given you a 2009 tax holiday on the required minimum distributions. You have no obligation in 2009 take any required minimum distributions out of your retirement accounts. And even if you did take out a distribution in 2009 up to $100,000 and donated it to a qualifying charity, you are not taxed on that withdrawal and do not deduct the contribution.
If your beneficiaries do not choose to take lifetime distributions out of your retirement account, then they have to complete all withdrawals out of the account within five years of your death. This five year rule also applies to non-individual beneficiaries, such as corporations and trusts, since these non-individual beneficiaries generally cannot elect lifetime distributions, with one exception.
The one exception to the five year rule for non-individual beneficiaries is if you named your trust as your retirement account beneficiary and your trust has been drafted to be a designated beneficiary. As a designated beneficiary, the IRS looks through the trust to the individual trust beneficiary ages to determine lifetime distributions.
I try to give my clients the most options possible. The trusts I draft are designated beneficiaries and qualify for lifetime distributions of retirement accounts to the trust beneficiaries. In order to qualify as a designated beneficiary, your trust must 1) be valid under State law, 2) have only individual beneficiaries, 3) have all beneficiaries identifiable, 4) be delivered to the plan administrator, and 5) be irrevocable upon your death.
Not all trusts are drafted to be designated beneficiaries. If you do name your trust as a beneficiary of your retirement plan account, and your trust is not a designated beneficiary, your retirement plan account must be completely withdrawn within five years of your death and all income taxes must be paid.
Usually discussions about retirement account distributions focus only on minimizing taxation. However, with proper planning, you can not only minimize taxes by spreading the distributions over years, but you can hold these distributions for your intended heirs in trust in order to provide personal instructions and directions to your loved ones.
The funds that are held in trust for your beneficiaries are often times held in lifetime trusts. Properly drafted, these lifetime trusts allow your beneficiaries to have access to the amounts in your trust for their needs. In addition, you can provide your beneficiaries with potential catastrophic creditor, catastrophic illness and divorce protection, while you still allow your beneficiaries to remain in practical control of their inheritance.
By: Matthew M. Wallace, CPA JD
Published edited June 28, 2009 in The Times Herald newspaper, Port Huron, Michigan as: Timing is an issue with IRA payments