New IRA Rules

THE IRS HAS SIMPLIFIED RETIREMENT

Allowing a person to leave their money in a retirement account, such as an individual retirement account (IRA), is a good thing. Appreciation in the value of assets held in IRAs is not taxable. Only when a distribution occurs does the gain realized become subject to income tax.

So, for example, a person could place $10,000 in their IRA at the age of 20, invest the $10,000 in stocks, sell some or all of the stocks, re-invest in other stocks, and continue to invest for 50 years before the person would be forced to begin taking distributions from the IRA. If over that 50 year period of time, the $10,000 grew in value to $500,000, no tax would be due until the distributions from the account began.

Better still, only the distribution is taxed, so the smaller the distribution the better. In most cases, the distribution is only a small fraction of the total account value, meaning that only that small fraction of the account need be taxed.

The Government has several, significant interests in retirement accounts. On the one hand, if people invest money in the markets (stocks, bonds), the economy gets a boost. If people invest money for their retirement, they’ll have financially prosperous retirement years – meaning they won’t be a drain on the economy.

On the other hand, the Government doesn’t want to defer income tax too long. The Government will let you invest tax deferred, but not tax free; eventually, you’ll have to pay the piper.

Up until least year, the Internal Revenue Services used a complex set of regulations to govern distributions from retirement plans. The regulations were so complex as to when, who, and how much had to be distributed from a retirement plan in any given year that enforcement of the regulations was near impossible – few people understood what was right or wrong.

Last year, in order to simplify the law (and simplify the enforcement of the law), the IRS published proposed regulations that would govern distributions from retirement accounts. On April 16th of this year, those proposed regulations became final, with a few modifications.

Under the new regulations, an account owner must begin taking minimum distributions by April 1st of the calendar year following the year in which the person turned age 70½. The minimum distribution is calculated by taking into consideration the value of the account and the age of the account owner. Based upon the age of the account owner, a life expectancy table that the IRS has published provides the owner with a divisor number.

The life expectancy tables that the IRS used before the new regulations hadn’t been updated since the 1970’s. The new life expectancy tables are based upon the year 2000 census. Since life expectancies are now longer than they were in the 70’s, the divisor number used to calculate the minimum distribution is larger, which results in a smaller distribution.

For example, the distribution for an account owner age 70½ was calculated using a divisor number of 26.2 – meaning that if the account were valued at $500,000, the first distribution was $19,084 ($500,000/26.2 = $19,084). Now, the same account owner age 70½ has a life expectancy of 27.4, meaning that the first distribution is $18,248 ($500,000/27.4 = $18,248).

If an account owner uses the new life expectancy tables and takes only the minimum required distribution each year, it is almost impossible for him to outlive his account. Ultimately, this means that tax deferral will continue even after the account owner dies, with account owners leaving significant amounts of money to their relatives.

The IRS’s new retirement plan regulations are an example of a rare creature, an IRS rule that is not only simple but actually has substantial benefits for the taxpayer and his or her family.