These are my notes from The Retirement Savings Time Bomb . . . and How to Defuse It: A Five-Step Action Plan for Protecting Your IRAs, 401(k)s, and Other Retirement Plans from Near Annihilation by the Taxman, 2003, by Ed Slott.
Ed Slott & Co. have a website with retirement help for advisors and consumers, irahelp.com. It includes updates of IRS decisions, the continuing changes to the law, life expectancy tables, etc. There's a revised edition of this book, in paperback, Dec. 2007; probably worth buying ($11 at Amazon) given the steady changes in the tax law and its thresholds (past, and to come).
IRS Publication 590 is the government's general reference for the tax law relating to Individual Retirement Arrangements (IRAs).
Slott's "five easy steps" to protecting your retirement savings from the taxman:
His big picture idea is that managing, protecting, etc. retirement assets is the "back 9," after the "front 9" of accumulating all that wealth for retirement. I guess he likes golf. 401(k)s and IRAs are great tools for deferring taxes, but as their contents are distributed, you have some planning to do to minimize taxes on the "back end."
Timing has to do with taking distribution of a pension when you can, the various options and risks. Early withdrawal exemptions avoid pre-59-½ penalty, but not the taxes due. Early withdrawal of earnings from a Roth IRA are taxable, too. Exemptions include:
Between 59-½ and 70-½, you can take out as much as you like, but of course you have to pay tax on it at the ordinary income rate. After the Required Beginning Date (RBD) (the year you reach age 70-½), you have to take the Required Minimum Distribution (RMD), which is subject to recalculation year-to-year (or not, depending on the circumstances).
N.B. that you have until April 15 of the year after you turn 70-½ to take the first RMD, but the second one will have to be taken in that same (second) year. If you don't want to pay taxes on two distributions in one year, treat Dec. 31 of the year you turn 70-½ to be your RBD. RBD Exceptions:
There is a 50% penalty for not taking your RMD! You have to pay half of what you didn't take out that you were supposed to as a penalty. This penalty applies to beneficiaries as well as the original owner of an IRA.
The RMD is calculated in various ways, depending on myriad constraints:
A Designated Beneficiary is an essential thing to have – a named beneficiary who is a person, and therefore has a life expectancy over which RMDs can be calculated. One's estate is not a designated beneficiary; a (non-designated) beneficiary who inherits via the estate, doesn't get the "stretch" benefit of the life-expectancy RMD. A non-designated beneficiary (as above, or non-person named beneficiaries) must empty the IRA by the end of the 5th year following the owner's death, and then pay the taxes on the resulting ordinary income.
A well-designed explanatory table would be good here. Slott doesn't provide one, but instead walks through the variants case-by-case.
A spouse who is a designated beneficiary has the choice to treat the IRA as his/her own, or remain a beneficiary; choose the method that minimizes your RMD (and current tax burden), in general. Relative ages of the couple, and whether or not the deceased has reached age 59-½ (when distributions may be taken) factor into the decision. The spouse can also delay distributions to when the owner would have turned 70-½. The spouse must be the sole beneficiary to do so; can split IRAs if need be to provide for that.
The spouse can remain a beneficiary to delay distributions, but once RMDs start, can change to "owner" and use the better/longer "Uniform Lifetime Table" for IRA owners instead of the "Single Life Expectancy Table" for beneficiaries.
If you have multiple IRAs, especially if some are inherited, keep track of them:
He's big on life insurance, to provide essential support for one's heirs, and to increase the size of one's estate, providing for estate taxes that may come due. He doesn't resolve the question of whether, if one's post-tax estate is "big enough," insurance is a good investment compared to alternatives. It's a tax-free bonanza when you die, but "time is money."
If you do get insurance make sure to keep the proceeds tax-free by keeping it out of your estate. Don't own your own life insurance – set it up so that the beneficiaries own the policy(s). You can give them the money to pay the premiums (i.e., pay the premiums, and call it a gift). An Irrevocable Life Insurance Trust (ILIT) can provide for postdeath control over how/when the money is spent. "The trust owns the policy and the trustee pays the premiums from the money deposited into the trust" (by the insured).
"Your goal is to keep as much as possible of your retirement account intact" (for the benefit of your heirs). By providing enough insurance benefit to cover estate tax, you prevent forcing your heirs to take money out of tax-deferred IRAs, and realizing concurrent double taxation for estate and income taxes.
One of the big issues is the moving target of the estate tax, from now, through 2010 when it "goes away" to 2011 when it "comes back" worse than before, thanks to a decade of inflation against the "fixed" threshold. Planning for the worst case is the "safe" approach.
How much should you have? "Enough to cover the taxes and other expenses that must be paid on your estate after you're gone." His rule of thumb is 50% of the projected value of your estate at your death! Keep in mind that you may not be able to add it "later," economically, as the premiums will go up, and your eligibility eventually will go away. (Non-liquid or non-divisible assets (like real estate – "the family farm") can create a demand on tax-deferred assets to pay estate tax that will trigger the double-hit on death.)
What kind should you buy? He defers to "your own professional insurance advisor," but recommends against "second-to-die" joint policies, unless one spouse is uninsurable alone.
N.B. Keough ("company") plans may allow you to purchase insurance with tax-deferred funds. You can't buy life insurance in an IRA, though. (The EGTRRA 2001 allows you to roll IRA funds into a company plan, and work around that limitation. C.f. end of his ch. 5.)
Stretch the tax deferral advantage of the IRA by making sure you have designated beneficiaries, that they understand the exact TITLING REQUIREMENTS (see below) for inherited IRAs, and what the RMDs will be. The basic requirements:
The details, advantages and caveats of converting a traditional IRA to a Roth IRA are complicated. Not sure he really helps one to figure it out... he does give a helpful list of "ways to reduce your income to qualify for a Roth conversion," which is relevant for a few more years, until the MAGI limit goes away (scheduled for 2010, per the Tax Increase Prevention and Reconciliation Act of 2005):
N.B.: Traditional IRA contributions cannot be used to lower income for Roth eligibility; AND, the income from a Roth conversion may disallow deductible traditional IRA contributions.
If you convert but then you find you weren't eligible (because you exceeded the MAGI limit), you have until the due date for that year's tax return plus extensions to recharacterize the funds back to the traditional IRA.
Not sure there's additional information here beyond recapitulation and reinforceent of the preceding, with Slott's storytelling.
His closing section deals with When things don't go as planned and gives information about early ["72(t)"] distribution, and fixing mistakes. Will come in handy for those who need it!
Tom von Alten tva_∂t_fortboise_⋅_org