January 19, 1998

Assets held in IRAs are not subject to income tax until distributed. If funds are not needed for living expenses during the early years of retirement, the value of IRAs will generally be maximized by delaying distributions and taking payments over the longest period permitted by tax regulations. Appropriate beneficiary designations can also help increase the amount of assets available for heirs by extending the total payout period, and consequently, the time in which assets can grow on a tax-deferred basis.

Minimum Distributions: The required beginning date (RBD) for minimum distributions from IRAs is April 1 of the year after the owner reaches age 70½ (minimum distributions are not required from Roth IRAs until after the owner’s death). If a minimum payment is not made in the year the owner becomes 70½, two payments will be required in the following year -- one by April 1 and another by the end of the year. Retirees should consider the tax consequences of "doubling up" of the first- and second-year minimum payments in the same calendar year.

After the RBD, the required minimum distribution must be made before the end of each calendar year. A 50% excise tax is levied on minimum amounts not distributed on a timely basis. Distributions in excess of this amount are allowed without penalties.

The general formula for computing the required minimum distribution for 1998 is as follows:

Minimum Distribution (Payable by 12/31/98)

=

Value of IRA at 1/1/98 Life Expectancy (IRS tables)

Under this formula, IRA assets are paid out over a period that does not exceed (1) the life expectancy of the owner of the retirement account, or (2) the joint and survivor (joint) life expectancies of the owner and designated beneficiary.

Life Expectancy: When computing the required minimum distribution, there are three basic options for determining life expectancy.

• Fixed Term: The life expectancy of the owner (and beneficiary) is used to compute the first year’s minimum distribution. Life expectancy figures (single or joint) are from the IRS’s life expectancy tables. In subsequent years, the original life expectancy is reduced by one year for each annual minimum distribution. Payouts can continue over the fixed life expectancy, even if the account owner and his/her beneficiary die before that time.
  
  
• Recalculation: Life expectancy is recalculated each year (using IRS tables). As one grows older, life expectancy decreases by less than one year per year (for example, a 70-year-old single individual has a 16-year life expectancy, but a 71-year-old has a 15.3-year life expectancy). The recalculation option results in the lowest required annual payout, and ensures that distributions will continue at least until the owner’s death. If recalculation is selected and a non-owner spouse beneficiary pre-deceases the owner after minimum distributions have begun, future minimum distribution calculations will be based on the owner’s life expectancy (that is, distribution will be accelerated). Upon the owner’s death without a surviving beneficiary, the IRA balance must be distributed by the end of the year following the year of death.
  
  
• Hybrid: A combination of fixed and recalculation is permitted (for example, the life expectancy of the owner is recalculated each year, but a fixed term is used for the spouse beneficiary).

There is no formal procedure for electing one of these options; however, taxpayers must be able to demonstrate that a consistent method was used to compute distributions in every year from the RBD onward.

Beneficiary Designations for IRAs: Beneficiaries should be selected before the RBD in order to use joint life expectancy for distribution calculations. The owner can change beneficiaries after the RBD; however, the amount of the minimum distributions cannot be less than the original calculation.

In addition to the IRA owner’s spouse, typical beneficiaries include the owner’s children, grandchildren, or other individuals (nonspouse beneficiaries), trusts (with named beneficiaries), and charities. If a beneficiary is not named, the balance in the IRA is paid to the owner’s estate.

• Spouse: If a spouse is the beneficiary, joint life expectancy can be used regardless of the difference in the spouses’ ages. Additionally, a deceased spouse’s IRA may be rolled over into a surviving spouse’s IRA -- the surviving spouse could then name his/her beneficiary, which would perhaps further extend the distribution period.
  
  
• Nonspouse: Joint life expectancy may be used with a nonspouse beneficiary; however, there is a 10-year maximum age difference for the joint life expectancy computation. Recalculation of nonspouse beneficiary life expectancy is not permitted.
  
  
• Trust: IRA assets can be placed in a trust for named beneficiaries (trusts are frequently used for transfers to minors, grandchildren, or others who are not capable of managing assets). Trust beneficiaries generally qualify as designated beneficiaries of a retirement account if certain conditions are met.
  
  
• Charity: Private foundations and charities can also be beneficiaries of IRA assets. Only the IRA owner’s life expectancy may be used for determining distributions. By operation of law, the account balance will be distributed to the charitable organization. The owner’s estate will not be subject to estate taxes on the amount contributed to the charity, and income taxes will not be levied on the retirement account balance.
  
  
• Estate: In most cases, the owner’s estate should not be named as beneficiary. If the beneficiary is the owner’s estate, the IRA balance must be paid out (1) within five years after the owner’s death, if he/she dies before the RBD, (2) within one year after the owner’s death, if he/she dies after the RBD and was recalculating life expectancy, or (3) over the remaining distribution period, if the owner dies after the RBD and was not recalculating life expectancy. In any case, a spouse who is the sole beneficiary of the owner’s estate may roll the distribution into an IRA.

The following chart illustrates distribution options (rollover availability and distribution period) available for different beneficiary scenarios:

Tax Considerations: Assets remaining in traditional (deductible) IRAs after the account owner’s death are subject to income and estate taxes. Such assets do not receive a step-up (to fair market value) in basis, as is the case for other estate assets. Retirement accounts are considered income in respect of a decedent (IRD) -- that is, taxable income to the beneficiary or the estate. When distributions are made, the recipient is permitted a miscellaneous itemized deduction (not subject to the 2% floor) for the estate taxes paid on the IRD asset (deduction in respect of a decedent). A similar deduction is allowed for an estate.

Tax on Excess Distributions: In prior years, a 15% excise tax was imposed on IRA distributions generally in excess of $160,000 (annual) or $800,000 (lump-sum). The Taxpayer Relief Act of 1997 repealed this excise tax, as well as the 15% estate surtax on excess accumulations in retirement accounts. The new law removes the "penalty tax" imposed on those who saved too much for retirement, and creates incentives for accumulating funds in tax-deferred retirement accounts.

These are some thoughts to consider about payout periods and beneficiaries for IRAs. Your financial and tax advisors can provide additional information and should be consulted before any action is taken.

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