Repeal of the excess distribution rules: Should you?

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	Taking the Excess Personal Finance Advisor by Deloitte & Touche OnLine February 17, 1997

Should you take advantage of the temporary repeal of the 15% "excess distribution" tax?

Tax laws provide incentives for individuals to save for retirement; however, excise taxes place limits on these incentives. One of the more intriguing tax law changes that became effective Jan. 1, 1997, is the temporary moratorium on the 15% "excess distribution" tax -- an excise tax that applied when annual gross retirement distributions exceeded a certain inflation-adjusted threshold.

For the next three years, individuals can withdraw unlimited amounts from qualified retirement plans (including IRAs) without incurring this excise tax. Not all taxpayers, however, will benefit from making large withdrawals (that is, accelerating withdrawals) from their retirement accounts during the next three years.

Income and Estate Taxes: The income tax treatment of withdrawals from qualified retirement plans remains unchanged. Once funds are removed from a qualified retirement plan, the taxpayer forgoes the opportunity to invest the funds on a tax-deferred basis. Additionally, a separate 15% excise tax remains in effect for large retirement plan accumulations remaining at the time of the taxpayer's death.

Factors to Consider: A decision to accelerate withdrawals from a retirement account over the next three years should consider the following factors:

The taxpayer's ongoing need to pay living expenses with distributions from retirement accounts that would normally have been subject to the excess distribution tax.
The current value of all retirement accounts.
The number of years until the first withdrawal.
The amount of minimum withdrawals that must begin at age 70½.
The projected tax rates, inflation rate, and average annual rate of return earned on investments.
The special "grandfather election" that might have been made on 1987 or 1988 tax returns.

The interaction of the above variables will determine whether a particular taxpayer should accelerate withdrawals to take advantage of the repeal. Analysis of these factors is best accomplished with individualized counseling from retirement planning experts using specialized software.

Taxpayers Who Might Benefit: Generally, individuals who are likely to benefit from the moratorium on the excess distribution tax will be in or near retirement and have a relatively large balance in their retirement account (for example, $1 million or more). Following are examples of taxpayers who might benefit from the repeal:

Individuals who have both retirement accounts and nonretirement investment assets and must decide on which assets to use first. The impact of income, excise, and estate taxes on retirement account assets differs greatly from the impact of such taxes on nonretirement account assets. For example, assets in nonretirement accounts receive a step-up in basis at the time of the owner's death; therefore, income tax is avoided on the amount the assets have appreciated. Assets held in retirement accounts are subject to income tax after the owner's death, but the tax may be deferred if younger individuals (e.g., children, grandchildren) are beneficiaries of the account.
Individuals currently receiving annual payouts exceeding $160,000 who expect to continue such withdrawals in the foreseeable future. These taxpayers have been subject to the excise tax and will resume paying the tax when it is reinstated on January 1, 2000.
Taxpayers who originally planned on delaying withdrawals until age 70½ and the withdrawals are likely to exceed the inflation-adjusted threshold in 2000 or 2001 (currently $160,000). Distributions taken during the next 3 years could reduce the accumulated balance in the retirement accounts so that minimum distributions after age 70½ will not exceed the threshold amount.
Individuals whose estates are likely to be subject to the 15% excise tax on excess retirement plan assets. Amounts withdrawn during the next 3 years will not be subject to the excess distribution tax or the estate excise tax, and these withdrawals may reduce the retirement account balances below the level where the estate excise tax applies.
Individuals who may be eligible for lump-sum distribution and favorable tax treatments, including 5- and 10-year forward averaging and the trustee cost rules for employer securities. In some circumstances, significant taxes can be saved.
Individuals who intend to leave a portion of their retirement account assets to charity. If withdrawals and charitable donations are made during the next 3 years, the 15% excess distribution tax would be avoided, and in most cases, the income and estate tax savings would be equivalent to the savings generated if the gift had been made after the taxpayer's death.

If your situation is similar to any of these scenarios, investigate whether you should accelerate or increase distributions from retirement accounts.

"Many taxpayers may not fit neatly into any of the above categories. The only way to know for sure if a taxpayer benefits from the temporary repeal of the excise tax is to compute the financial impact of accelerating distributions versus deferring distributions over many years," notes Robert Bult, Financial Counseling Specialist, Deloitte & Touche LLP.

These are some thoughts that should be considered before accelerating withdrawals from retirement accounts in order to take advantage of the temporary moratorium or the 15% excess distribution tax. Your tax advisor can provide additional information and should be consulted before any action is taken.