Complying with the minimum distribution rules for traditional Individual Retirement Accounts (IRAs) has, until recently, been mind-numbingly complex. Even “experts” frequently made calculation errors, which could result in the imposition of income taxes and stiff penalties amounting to 50% of any shortfall (excess accumulation) that should have been distributed.
Recent legislative changes drastically reduce the complexity inherent in the original rules by simplifying the calculation of required minimum distributions (RMDs) and by providing greater flexibility in choosing or changing beneficiaries. (Note: Roth IRAs are not subject to either the old or new minimum distribution requirements.)
Why Minimum Distributions?
Federal tax laws allow eligible individuals to make income tax-deductible contributions to an IRA, subject to specified limits. All IRA contributions, regardless of deductibility, enjoy tax-deferred growth. “Tax deductible” and “tax deferred” do not mean tax free, however, and income taxes must eventually be paid on IRA dollars. To assure the timely collection of these taxes, the Tax Code prescribes that RMDs must begin by April 1st of the year following the year you reach age 70½.
The original rules involved elaborate calculations and restrictive elections using multiple tables to determine the RMD each year. Current rules greatly simplify this process by establishing one uniform table, generally referred to as the Minimum Distribution Incidental Benefit (MDIB) table, for calculating distributions that generally allows the smallest distribution possible under the original rules. If your only other beneficiary is your spouse, and he or she is more than ten years younger than you, a second table (joint life and last survivor expectancy) is available that calculates the distribution period based on your actual joint life expectancy, thus resulting in an even lower minimum distribution.
To calculate your minimum distribution, you need to divide the total balance of your IRA assets as of the end of the preceding year by the divisor published by the IRS in the appropriate table based on your current age. Be aware that you must consider the values of all your IRA accounts in determining your minimum distribution amount, although taking a distribution from each account is not required. Rather, once the minimum distribution is calculated, you may withdraw it from any of your accounts in any combination you choose.
There are no penalties for taking a distribution greater than the minimum required in any particular year, though doing so will not directly reduce the amount you must take the following year. However, your minimum distributions in future years will be affected indirectly because the total balance in your IRA accounts will be less than it otherwise would have been.
Under the old system, you were also obliged to make an irrevocable beneficiary designation by age 70½, even though your financial circumstances could change significantly in subsequent years. The new rules allow for the selection of a designated beneficiary up until the account owner’s death—even after RMDs have begun—and a change of beneficiary to be recognized as late as December 31st of the year following the account owner’s death. This should provide greater flexibility when it comes to estate planning. For instance, a surviving spouse, who does not need the income to live on, could “disclaim” the inherited IRA in favor of another, previously named contingent beneficiary, such as a child or grandchild.
Better Safe than Sorry
These simplified rules should make it easier for retirees to meet the minimum distribution requirements and avoid unnecessary penalties. However, be aware that any potential build-up in tax-deferred assets could lead to higher estate taxes down the road. If you have an IRA and have attained (or are approaching) age 70½, it may be best to consult a qualified tax and financial professional for assistance with your particular circumstances.