With the introduction of the Roth IRA under the Taxpayers Relief Act of 1997. There is much hype about the possibility of creating a retirement plan from which you'll be able to withdraw funds free of federal income taxes. Yet for many people, particularly those approaching the age of 70, rolling your traditional IRA into a Roth IRA may not be an attractive option. For these folks, understanding the rules applying to your traditional retirement account (IRA) is critically important. Failure to understand IRS' IRA rules and properly integrating your individual retirement account planning with your overall estate planning can spell disastrous results. The reason: unpaid federal and state income taxes and the possibility of estate taxes resulting from your IRA account.

    It is not unusual for individuals approaching retirement to have accumulated $200,000 or $300,000 in their IRA. I have seen IRA accounts approaching $1 million. With the current estate tax exemption at $625,000 and income taxes due on withdrawals from your IRA, careful planning is necessary to minimize the potential tax bite.

Several definitions are important.

First:
    "RBD" = Required Beginning Date
    "DB" = Designated Beneficiary
    "ALE" = Applicable Life Expectancy
    "SRO" = Spousal Rollover
    "P" = Participant (you)

    The traditional IRA account is a tax deferred account held by a custodian for a participant subject to both federal estate and income taxes (as well as state taxes). Uncle Sam wants those taxes paid. If you are a participant in a traditional IRA arrangement (not a Roth IRA), the government wants you to begin paying the income taxes due on your IRA in the year you reach the age of 70-1/2. Your first payment can be delayed until your RBD (Required Beginning Date) which is April 1 of the year after you reach 70-1/2. But you still owe a payment for the year you reach 70-1/2, so if you wait until April 1 and you're 71 years of age, you must take out two withdrawals and pay taxes on both.

    Determining the minimum withdrawal required can be complicated. Simply stated, your minimum withdrawal required after you reach your RBD is calculated on your applicable life expectancy ("ALE"). The Internal Revenue Service gives you several options for determining your ALE. You must elect one of these options before your RBD and your election is irrevocable. If you make the wrong election or you fail to make an election at all, the results can be catastrophic.

    You can withdraw your IRA funds at any time after reaching 59-1/2 and pay the income tax. Most participants want to defer paying any tax until the last possible moment. Therefore they delay distribution until their required beginning date ("RBD"). At that time, they must elect to begin withdrawals. The longer you stretch out your withdrawals, the more the account can grow tax deferred. If you make the right choices and the right election, an individual participant can theoretically stretch the withdrawals from their IRA account over their life expectancy as determined by the IRS and the life expectancy of the DB (designated beneficiary). This could produce amazing results if the DB were, for example, a grandchild who, for example, was two years old at the time the participant reached 70-1/2.

    In any event, the choices you make at your RBD are very important. As you approach 70-1/2 it is extremely critical that you discuss these options with a knowledgeable financial planner or estate planning professional. If your goal is to minimize your withdrawal and maximize your tax deferral and accumulation in your IRA account after you reach your required beginning date, then you will want to calculate your withdrawal on the maximum applicable life expectancy.

You have these choices:

    First, you can elect to calculate your withdrawal over your own lifetime.

    Second, you can elect to withdraw your IRA over your lifetime and the lifetime of your DB (designated beneficiary). If you named more than one beneficiary to your plan (and you should check your plan immediately to make sure that you have named a beneficiary and a contingent beneficiary or beneficiaries), then the oldest beneficiary is your DB and the ALE (applicable life expectancy) would be determined based on your age and the age of the oldest beneficiary. These life expectancies are determined using a table provided by the Internal Revenue Service in IRS Publication 590 entitled "Individual Retirement Arrangements." You will need this publication before you can make an informed election regarding withdrawals from your IRA.

    Third, you may elect to recalculate life expectancy each year after you reach 71. Recalculation can be dangerous because in the year of your death your life expectancy is reduced to zero and your beneficiaries will normally have to withdraw all of your IRA account before December 31 of the year after your death. If you have a large IRA account, the income taxes on the entire amount would normally be due at that time. If you wish to avoid forcing an immediate payout from your IRA account, you should avoid recalculating your life expectancy. Then if you die prematurely, your beneficiaries may withdraw the IRA account on what remains of your life expectancy and, in most cases, what remains of the life expectancy of your designated beneficiary. If this were a grandchild, for example, the withdrawals could be stretched out for many, many years and the IRA account permitted to grow tax deferred over that entire period. For example, a $250,000 IRA account where the participant elected a 40-year old child as their designated beneficiary, could grow over their child's life expectancy after their death to over $1.5 million. This would not happen if the beneficiaries were forced to withdraw the IRA balance within the year after your death. If you name someone other than your spouse as your designated beneficiary and that individual is more than 10 years younger than you are, then during your lifetime you are permitted to use only 10 years of the designated beneficiary's applicable life expectancy for determining your withdrawal. However, at your death the designated beneficiary may revert to their own applicable life expectancy to determine the continuation of withdrawals. This can be particularly beneficial if you have named someone significantly younger than yourself for they now can withdraw over their applicable life expectancy and permit your IRA account to build up over their lifetime. This could provide a substantial fund for that individual in his/her own retirement years.

    There are special rules when you name your spouse your designated beneficiary. First, you may use your spouse's entire life expectancy in determining your withdrawal amount. In other words, you use a joint life expectancy table. If you recalculate both you and your wife's life expectancy, you can stretch your IRA out over an extended period of time. However, recalculation can be very taxing to your heirs if both you and your wife die prematurely since your life expectancies will be reduced to zero. However, if your spouse survives you, your spouse has the option to roll your IRA over into a new IRA in your spouse's name and designate a new designated beneficiary. Only spouses named as designated beneficiaries have the right to roll over an IRA account into a new account. It is particularly important that the spouse roll the IRA into a new account and not into their own old account. If the spouse is over 70-1/2 and they roll the IRA into an old account, they are "stuck" with their original designated beneficiary who is probably their deceased spouse. They will then lose the ability to stretch the IRA's payout over the lifetime of a new designated beneficiary -- perhaps a child or grandchild.

    In summary, it is extremely important to consider carefully your options in determining your minimum withdrawals at your required beginning date. Particularly important is the determination whether to calculate or recalculate your life expectancy for minimum distribution purposes and to determine who to name as your designated beneficiary when you reach your required beginning date. This election is irrevocable with respect to determining your minimum withdrawals. And while you can change your beneficiary at any time, your designated beneficiary at your required beginning date will determine your minimum distribution requirement regardless of whether you change the beneficiary later or not. If you are approaching the age of 70-1/2, you will need to consult with a knowledgeable professional regarding your options for determining withdrawals from your traditional IRA and incorporating your IRA planning into your overall estate planning to determine not only your income tax liability but your potential estate tax liability.