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By John M. Bigler For most people, a home is the single most valuable asset they own. The second most valuable may be an Individual Retirement Account. An IRA represents savings accumulated over a lifetime of work that have grown free from income tax. The special qualities that make IRA's an attractive way to save for retirement also carry limitations. The Internal Revenue Service is implementing new regulations regarding taxation of IRA's that will simplify planning around those limitations. The new regulations become effective January 1, 2002, but they may be used for distributions taken in the year 2001.
An inherited IRA may be taxed twice: once by the estate tax at death and then, again by income tax as it's distributed to the beneficiary. A Roth IRA won't suffer from the same double taxation after death as a traditional IRA because that money was already subject to income tax in the year it was invested.
It may be preferable to leave an IRA to a charity. An estate that's greater than the estate tax exemption amount, which is $675,000 this year, could benefit from a deduction equal to the amount given to the charity. Additionally, the charity won't pay income tax on the distribution that it will receive from the IRA, meaning that it will get the full benefit of the gift.
The Internal Revenue Service wants to tax as much of the money saved in the IRA as quickly as it possibly can, once distributions begin. In order to avoid people simply leaving money in an IRA indefinitely to continue to grow tax free, the I.R.S. has rules for the minimum amount that must be withdrawn each year. The minimum required distributions are based on the taxpayer's life expectancy and the life expectancy of the plan's designated beneficiary.
Under the old rules, the date for determining the beneficiaries of an IRA was the account owner's date of death. Under the new rules, the determination can be made as late as the last day of the year following the year of the owner's death. This allows some time to decide who will receive the benefits of the IRA and how.
This gives beneficiaries an opportunity to make a disclaimer and allow their share to go to either other co-beneficiaries or secondary beneficiaries. This may be useful in cases where a person allowed their interest in an IRA to pass on to their children or other younger relative. The younger person has a longer life expectancy. The beneficiaries may decide to divide the IRA among themselves and to calculate distributions separately for each based upon the life expectancy of each person. This can be especially important when a charity is a named beneficiary of an IRA. Where a non-person, such as a charity, is named as a beneficiary, there are special problems.
An institution, such as a charity, doesn't have a life expectancy. Unlike us mere mortals, a charity can go on forever. The I.R.S. isn't going to wait forever to tax those distributions. It requires a faster payout of funds to this kind of beneficiary than it would to a person. The old rules would force any other human beneficiaries to take larger distributions than otherwise because one of the beneficiaries is an institution. The new rules will help with this difficulty. A single beneficiary may receive a distribution from the IRA and leave the remainder to be divided among the other beneficiaries. If this is done in the year allotted to determine beneficiaries, that single beneficiary will not be used to calculate the required minimum distributions for the others.
Although the new rules do allow some additional flexibility in deciding who among the named beneficiaries will receive the IRA, it does not allow entirely new beneficiaries to be named. You can pick and choose, but only from among the choices that the plan owner gives you.
Reprinted with permission of the Suffolk Times © 2000
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The main benefit of IRA's is that money isn't subject to income tax in the year it's deposited, instead it is taxed in the year it's withdrawn from the plan. This is helpful because an individual presumably won't start taking distributions until he's retired and earning less money, which therefore will be taxed at a lower rate. Income earned by the money invested also isn't taxed until it's withdraw from the account, so it's able to grow that much faster.