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One of the most important decisions that an IRA Participant (P) needs to make before the first required
distribution is whether to recalculate his or her life expectancy (for determining the amount of the minimum
distribution) and, furthermore, whether to recalculate the life expectancy of the designated beneficiary, if that
beneficiary is a spouse. As you are no doubt aware, if an individual beneficiary is designated, a joint life
expectancy calculation can be made in determining the amounts of the minimum distribution.
RECALCULATION OR NOT?
P can elect the recalculation, term certain, or hybrid method for determining minimum distributions.
Many, if not most, standard plans provide that recalculation of both life expectancies is the default provision. If
both P and spouse (S) live beyond their life expectancies, this method would produce the maximum deferral
(or minimum annual payout). However, if P and S both die prematurely, the heirs or family would not get the
benefit of a longer payout. Plan assets would have to be distributed before the end of the year following the
year the survivor dies.
Recalculation, of course, can extend the payout period because when life expectancy is recalculated each
year, the expectancy goes down by less than a full year. For example, the life expectancy of a 70 year old is 16
years while that of a 71 year old is 15.3 years.
Take the case where no election is made before the first required distribution and therefore the life
expectancies of both P and S are recalculated annually. Remember that the method of determining the
minimum distribution can’t be changed after the first required minimum distribution (for the year in which P
reaches age 70 ½ ). What happens if S unexpectedly dies first? The life expectancy of S goes to zero and
therefore minimum distributions to P are determined by P’s life expectancy. Then if P were to die prematurely,
all the plan assets would have to be distributed out within two years (the year of P’s death and the year
following) with a large tax payable from the plan benefits.
The term certain method for both P and S gives the maximum guaranteed deferral as the payout is calculated
on a joint life basis at age 70 ½. This avoids the need for an accelerated payout.
As a hedge against this possibility, many advisors recommend a "hybrid" election whereby the life expectancy
of either P or S is recalculated, while the other is fixed ("term certain"). By this method, there is a "term certain"
over which the balance of the plan benefits can be withdrawn and still gives a possible stretch out if P lives
beyond his life expectancy.
WHICH METHOD IS BEST?
The hybrid method is most often recommended where attention is given to the minimum distribution
calculations. That is, an election is made to have P’s life expectancy recalculated annually, but not S’s. Thus,
if S dies first, P and P’s heirs will be assured of distributions over S’s original life expectancy. Of course, if P
dies first, then S can rollover the benefits into a separate IRA and start the process all over again by electing a
new designated beneficiary.
However, this might not always be best. If P and S had below average life expectancies, using a fixed term
certain would probably produce a longer payout period and more tax deferral where this is of interest to the
family. Again, the choice of beneficiaries and the method of calculating the minimum distributions will depend
upon not only the health of P and S, but their relative financial positions, the degree of financial security
desired, and the size of the IRA in relation to other assets. For example, if the IRA is seven figures and a
significant part of family wealth, heirs and family may be more concerned with tax deferral then the case
where the IRA benefit is likely to be drawn out in full by the heirs after the death of P and S.
Hybrid Method Drawbacks.
Are there any drawbacks to the hybrid election? While the hybrid election is usually more complicated, this is
generally easily solved by the software of the plan sponsor or tax advisor. Observers note that required
distributions under the hybrid method are slightly larger in the early years due to the IRS formula of adjusting
or rounding of S’s age. Finally, the hybrid method creates considerable pressure for S to complete a rollover
after P’s death.
Handling of IRA accounts is one of the most important, high priority items of post-mortem tax planning.
In many cases, clients may be reluctant to talk about what happens to IRA benefits after the death of both
spouses at a time when both are in good health and below the age where the elections become binding (P’s
first required minimum distribution). These plans or predictions may be affected by the relative financial
position of the children. That is, a more financially successful child may be more inclined toward continued
deferral than a child that needs the money and is not in a high tax bracket. Such a situation might favor
dividing the IRA into separate accounts, either with different elections or different designated beneficiaries.
This may be especially appealing where the IRA is far larger than is needed for reasonable support for P and
S as they get older.
The important point to remember in these deliberations is that it is important to discuss the future, the
options, and the possibilities with clients, and make sure that the estate planning professionals go into some
detail so that intelligent choices are made on a timely basis. This is a complicated subject that tends to make
the eyes glaze over. However, it is a professional’s duty to make sure that various possibilities and options
are explored with your clients. IRA benefits have to be integrated with client’s family and tax planning and we
stand ready to provide expert assistance to you and your clients without getting so academic that the clients
go to sleep.
©BRANDT, FISHER, ALWARD & ROY, P.C.
This newsletter is provided for informational purposes and should not be acted upon without professional
advice.
| WEALTH CONSERVATION: PROFESSIONAL ALERT Brandt, Fisher, Alward & Roy, P.C. |
| February 2000 IRAs - TO RECALCULATE OR NOT by James R. Modrall III |
| If you would like to receive future editions of the monthly Wealth Conservation Newsletter directly to your e-mail account, please e-mail our office using the following link: Estate Planning Newsletter |
| Brandt, Fisher, Alward & Roy, P.C. Attorneys at Law |