Here are major points of the new tax law concerning contributions to and distributions from retirement plans that are of most interest to our readers.

  • The age for the required minimum distribution for the commencement of retirement benefits has been increased from 70½ to 72.
  • IRA owners may contribute to traditional IRAs if they are otherwise eligible, after age 70 ½.
  • Qualified plan and IRA monies must be distributed to the beneficiary within 10 years after the death of the participant or IRA owner.

The name of the game is deferral. The longer money is allowed to grow untaxed, the bigger the accumulation.  And the longer the Treasury has to wait to get tax revenue.

Under the old law, most business owners needed to commence distributions from pension plans, profit sharing plans, and IRAs starting when they are age 70 ½.  The new law changes it to age 72. That gives us one or two more years of deferral depending upon your birthday.  That’s the good part.

The bad part is the deferral period after death.  With five exceptions (discussed below) the new act provides that accumulations in pension, profit sharing and IRAs, must be paid out in full within 10 years of the death of the participant or IRA owner.

The old law was that most accumulations could be paid out over the life of the beneficiary. For example, Robert has accumulated $2,000,000 in his IRA and dies at 75.  As Robert’s spouse predeceased him, he leaves the entire amount to his only child, Dana, then age 30.  Dana’s life expectancy is approximately 52 more years measured from the following year.  She is required to take out 1/52 of the accumulation in year 1, 1/51 of the remaining accumulation in year 2, and so on.  Most likely, it will be years before the distribution exceeds the growth.  Until then, the pie keeps growing.

Under the new law, Dana would have to take out all monies within 10 years.  She would need to meet with a financial adviser to determine how quickly and how much to take out each year.  This involves an interplay between tax brackets and the time value of deferral.  Assuming 6 percent earnings each year, she would need to take out almost $272,000 annually to amortize the fund.   If she chooses to wait until the end of the 10 year period, she would need a lump sum of $3,582,000 to deplete the fund, assuming the same rate of return.

The first exception to the 10 year rule are spousal rollovers. In the new example, Robert is survived by his spouse, who is age 66.  She could treat the accumulation as her IRA and delay the start of the 10 year death rule until she dies.

The other exceptions to the 10 year rule are for beneficiaries (i) who are minors, (ii) who are disabled, (iii) who are chronically ill, and (iv) who are no more than 10 years younger than the decedent.  In the case of a minor beneficiary, as soon as he or she reaches the age of majority, the 10 year period begins. In addition, the minor must be a child of the participant or IRA owner.

Some beneficiaries of qualified plans or IRAs are trusts rather than individuals.  Without a trust, there is nothing to prevent the individual beneficiary from taking all funds on day one. Trusts are set up to prevent this and often used for younger beneficiaries, spendthrifts, those with marital or creditor issues, and those who are likely to be sued (e.g., doctors).

There are two types of trusts that are used for this purpose.  A conduit trust must pay out to the beneficiary any amounts received from the qualified plan or IRA.  An accumulation trust may accumulate and defer the payment to the beneficiary of amounts received from the qualified plan or IRA.

With the change to a 10 year maximum, the frequently used conduit trust may need to be changed to an accumulation trust depending on how much is the qualified plan or IRA and whether the ultimate beneficiary is in a vulnerable situation as explained above.  Otherwise, the rate of payout to a beneficiary might be too large.

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