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IRS Changes Required Minimum Distributions Rules

On 4/17/2002, the IRS issued new final regulations that drastically changed the required minimum distributions rules for IRAs and qualified plans.  Detailed information may be found at the NewRMD.Com Web Site which also includes an online calculator. 

Free Social Security Benefits Software

For Social Security benefit calculations, there is no better program than one from the Social Security Administration itself. Although one may order it on a disk for only $51, it is available for free downloading on the Internet. The program is called AnyPIA (PIA stands for primary insurance amount) and is better than any commercial program that claims to calculates Social Security benefits. For phone orders ($47 plus $4 shipping), call NTIS at (701) 605-6000 and order #PB97-503478. Interestingly, the downloadable program is more up-to-date than the one that you can order over the phone.

15% Excise Taxes on Excess Distributions and Excess Accumulations Repealed

The Taxpayer Relief Act of 1997 that was signed into law on 8/5/97 repealed the 15% excise taxes on excess distributions after 12/31/96 and excess accumulations for decedents dying after 12/31/96.

In its 7/21/97 issue, Fortune magazine had an article, A Timely Death for a Dumb Tax, by Jeffrey H. Birnbaum (p. 27). The title of the article says it all. Apparently, the repeal provisions were inserted at the request of Sen. Phil Gramm.

Five-Year Lump Sum Averaging

The availability of five-year lump sum averaging expired after 12/31/99. Unless you plan to take the money out soon for other reasons, using five-year averaging seems to be a bad idea for most people. This was discussed in great detail in an excellent article, The Five-Year Itch by Ashlea Ebeling in Forbes (11/29/99, p. 238). The article's conclusion was: "...should anyone rush to use five-year averaging? Yes. Taxpayers between the ages of 59½ and 63, who have smallish retirement accounts that they either want or need to spend soon."

Roth IRA

In the tax bill enacted on 8/5/97, the new Roth IRA was created. Roth IRAs (formerly proposed as the American Dream IRA or the IRA Plus) may be set up starting in 1998.

For individuals with AGI not exceeding $95,000 and for joint filers with AGI not exceeding $150,000, nondeductible contributions of $2,000 can be made annually (even after age 70½). Qualified distributions from a Roth IRA would not be includible in income, i.e., such distributions would not be taxable.

Qualified distributions (which are not includible in gross income) are those that are made after a five year taxable period and which meet one of the four following criteria: after age 59½, made to a beneficiary (or one's estate) after death, attributable to being disabled, or for certain qualified first-time home buyers. As a practical matter, once you are over age 59½ and a five taxable year period has passed, all distributions become qualified distributions.

However, even if a distribution is considered to be nonqualified, such distributions are considered to be made first from contributions to the Roth IRA. Since such contributions have already been taxed, they are apparently not subject to taxation on withdrawal. It is only once amounts exceeding contributions have been withdrawn that such nonqualified distributions apparently become taxable. What all this means is that any contributions you have made can be withdrawn at any time without incurring additional income tax liability. Of course, if you withdraw before age 59½, you would still have the 10% penalty for early withdrawals.

The pre-death minimum distribution rules that apply to IRAs currently would not apply to Roth IRAs. Post-death distributions would be subject to the minimum distribution rules. (That is good news since it means that Roth IRAs could be continued after the death of the owner—paying tax-free income from a fund which is growing tax-free!)

Under the the new law, existing IRAs could be converted into Roth IRAs in 1998 or later. However, there is an income test. You cannot convert an existing IRA to a Roth IRA in any year in which you have AGI exceeding $100,000 (or if you are a married individual filing a separate return). If you pass the AGI test, there is no limit on the amount that may be converted. (Only conversions in 1998 resulted in converted amounts being taxable over a four year period starting in 1998 by adding 25% of the amount to gross income each year. Conversions in later years result in the full amount being taxable in the year of the conversion.) (Note: The amount being converted into a Roth IRA does not figure into the $100,000 AGI test.) The conversion issue is a complex one to evaluate and, where the potential tax is substantial, the services of a professional planner should be considered. (Interestingly, the conversion often makes the most sense for those with large pension balances who are approaching age 70½.)

Everyone with an existing IRA should evaluate whether to convert their existing IRA to a Roth IRA.
Drawbacks: Paying tax for the conversion year and, for those with taxable estates, loss of the IRC §691 deduction for estate tax attributable to IRD. Paying the tax at a 40% rate (in many cases) is a high cost even if you have the money available to pay the taxes.
Advantages: Tax-free growth and tax-free distributions, potentially for decades. If you don't need to access the funds yourself, you can keep contributing until you die and your beneficiaries could presumably withdraw tax-free amounts for some period of years after your death (if set up properly!) with tax-free growth continuing in the meantime. If your estate is subject to federal estate tax, the amount used to pay income tax on a conversion to a Roth IRA will not be in your taxable estate.

For the latest information on Roth IRAs, see the Roth IRA Web Site at http://www.rothira.com.