Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: MONDAY, July 12, 1993 TAG: 9307090363
SECTION: BUSINESS PAGE: B6 EDITION: METRO
SOURCE: MAG POFF STAFF WRITER
DATELINE: LENGTH: Medium
The Institute of Certified Financial Planners noted that people who reach the age of 70 1/2 are required to begin withdrawing funds from retirement accounts.
Examples are Individual Retirement Accounts, Keogh plans, 401(k) plans and Simplified Employee Pension Plans.
"However, you have options about calculating how you want those funds distributed," the institute said, "and a wrong choice can prove expensive."
According to the law, you must begin withdrawing at least a minimum portion of your funds - or all of your funds if you wish - no later than April 1 of the year following the year in which you turn 70 1/2.
And you must take at least that minimum by each subsequent Dec. 31.
If you fail to make a withdrawal in time, the institute said, or if you don't withdraw the required minimum, you may have to pay a penalty.
The penalty is 50 percent - a full half - of the minimum amount not distributed.
For example, if the minimum distribution is $25,000 and you take out only $20,000, you could pay 50 percent of the $5,000 shortfall, or $2,500.
That's in addition to the regular income tax you would pay on all taxable withdrawals.
What is the required minimum distribution each year?
That's where the options come in, the certified financial planners said. They gave this account of the choices:
In general, the minimum amount you must withdraw is based on the total value of your qualified plan accounts divided by your life expectancy.
Or you may use the life expectancy of you and a named beneficiary, such as a spouse or child.
As an example, if you and your spouse both turn 70 1/2 this year, your combined life expectancy according to IRS tables is 20.6 years.
If the total value of your retirement accounts is $500,000, the minimum withdrawal the first year is $24,271 ($500,000 divided by 20.6).
The next year's withdrawal generally will be larger because your life expectancy will be shorter and the account will likely have grown in value.
But there are two methods of calculating your withdrawals that affect the size of subsequent distributions.
These are the term-certain method and the recalculation method.
Under term-certain, the institute said, you base the withdrawal on the initial life expectancy calculation. Then you make the appropriate withdrawals until the retirement accounts are emptied by the end of the fixed number of years - 20.6 years, for instance.
The recalculation method requires recalculating your life expectancy each year.
Statistics tell us that for each year you live, your overall life expectancy lengthens. Thus, each year's withdrawal is smaller than it would be under the fixed-years method.
This method is more common, and it is usually the method by default if you don't indicate otherwise.
The planners said it works best for those who want to stretch out their withdrawals. By minimizing withdrawals from tax-deferred accounts, your account will usually continue to grow for several years before larger and larger withdrawal requirements begin to drain the account.
The only catch to this method, the institute said, is if you and any named beneficiary die sooner than normal life expectancy.
Then all remaining funds in the accounts must be distributed by the end of the year following death.
In that case, the funds would no longer grow tax-deferred, and the tax bite could be steeper than under the minimum withdrawal method.
Under the term-certain method, however, the minimum withdrawals can continue to be made even after death, thus saving taxes for your heirs.
The one potential drawback to the term-certain method comes, on the other hand, if you live beyond those fixed years. Then you would have no funds left to withdraw for income to live on.
The planners said the choice of which calculation option to use must be made by the time you make your first withdrawal. And the decision is irrevocable.
You should look at the longevity history of your own family and at your own health before making a decision. You may also want to consult a planner or tax adviser before settling on a method.
by CNB