By James W. Mallonee
When Individual Retirement Accounts (IRA) were first introduced in the late 1970’s it was generally understood you could place $4,000.00 into a tax deferred account and at some time in the future you would get it back following retirement. That’s about all we knew; fast forward 40 years and how IRA investments work when getting ready to pull it out as retirement income can be a mystery. This article will give you the basics of the rules involving IRAs; there is no discussion involving Roth IRAs.
Contributions to your IRA are limited to the lesser of 100% of your earned income per year or $6,000.00 in 2019. If you are over 50 years of age you can contribute up to $7,000.00 annually to your IRA. Your ability to continue to contribute to your IRA stops at age 70 ½, unless Congress increases the age requiring you to begin taking your required minimum distributions or increases the amount you can contribute.
Your contributions to your IRA were not taxed when contributed nor during the years preceding your 70 ½ birthdate. The beauty of the IRA is that the gains made on the invested funds are also not taxed. This gives your investment the ability to increase in value without having to pay taxes on those capital gains made when buying and selling stocks or other equitable assets as you get closer to age 70 ½ years. However, its when you begin taking distributions from your IRA that taxes will be paid on the amount removed (generally recognized as Minimum Required Distributions (MRD)).
You must begin taking MRD’s at age 70 ½ which is treated as ordinary income and taxed at IRS standard rates. At death, the remaining value of the IRA is calculated into a decedent’s gross estate. Fortunately, in today’s environment, the applicable exclusion for Federal Estate Tax is $20 million for a husband and wife or $10 million for a single individual plus any portable amounts from a pre-deceased spouse. Should an IRA owner fail to begin taking the MRD at the required time following age 70 ½, you may be liable to the IRS for a penalty of 50% between the difference of the actual distribution amount withdrawn and the mandatory amount to be taken.
You can begin withdrawing from your IRA at age 59 ½ without penalty. Should you begin withdrawing from your IRA at age 59 ½, you do not have to take the MRD amount at that time, but you must take the fully calculated MRD after you reach 70 ½. The latest date you can defer taking your mandatory MRD is April 1 of the calendar year following the year you reach age 70 ½. Thus, a person who is 70 ½ in February, 2019, must take his or her mandatory MRD on or before April 1, 2020. All subsequent MRD payments following the one in April 1, 2020, must be received by December 31, 2020 and each year thereafter. It is possible to pick two payments in the same year as demonstrated above. You can withdraw each month, but the total of the withdrawals must equal the mandatory MRD for that year.
The MRD is calculated yearly and is based on the value of the IRA at the close of business on December 31 of the preceding year. That value is divided by the life expectancy for an individual found in the IRS regulation tables §1.401(a)(9)-9. This mathematical calculation is done each year.
At the death of the IRA owner, the IRA is allowed to pass to the designated beneficiaries named in the IRA. The beneficiary must be a natural person as opposed to a decedent’s estate or trust instrument. If the beneficiary of your IRA is not a natural person, then in such event your IRA will be treated as having no beneficiary.
The distribution of a decedent’s IRA depends upon when the decedent passed and who is the recipient of the IRA. For example, if the decedent dies before reaching 70 ½ years of age and no beneficiary is named, the entire balance of the IRA is to be distributed in either a lump sum or over a period of 5 years to the decedent’s estate. If there is a designated beneficiary the entire IRA may be rolled over to the spouse or named beneficiaries based on specific rules.
If the designated beneficiary is not the surviving spouse. The inheriting beneficiary may have the funds rolled over into an IRA account of their own on a direct transfer from one administrator to another. If this is accomplished, the amount transferred is not considered income to the receiving beneficiary and therefore not taxed. An inheriting beneficiary cannot contribute to the rolled over IRA and no other rollovers (where the decedent has multiple IRA accounts) should be included in the same account. In essence, the accounts are separate. The inheriting beneficiary may take the full amount of the IRA or (in most cases) stretch the MRD’s over their life expectancy (provided the rollover is completed before December 31 of the year following the death of the original IRA owner). If the election is to take the life expectancy route, the calculation is once again calculated each year.
The surviving spouse has different alternatives. He or she can elect to roll over the deceased spouse’s IRA and take ownership of it, including depositing it into their own IRA account or in a separate one in their name (like an inherited IRA). If the decendent was younger than 70 ½ years old, the spouse can delay taking the MRD’s until he or she reaches 70 ½. If the surviving spouse takes ownership of the decedent’s IRA, the surviving spouse will then be subject to the rules as if he or she initiated the IRA before reaching 70 ½. However, if the decedent (upon death was 70 ½ years old or older), the surviving spouse will take the MRD’s based on his or her life expectancy or that of the decedent. But remember, that a surviving spouse may take full ownership of the decedent’s IRA as their own. Upon the death of a designated beneficiary (e.g. spouse), who has taken possession of the IRA, the remaining IRA balance must continue to be distributed in the same manner or more rapidly under the current distribution mode.
What about a trust beneficiary? An IRA cannot name a trust as a beneficiary because it is not a natural person. However, trust beneficiaries may qualify as a designated beneficiary provided the trust is valid, irrevocable or becomes irrevocable following death of the Grantor with identifiable beneficiaries (natural persons) and deliverable by October 31 of the year following the Grantor’s death to an administrating financial institution. The IRA’s MRD must be directed to the trust beneficiary (these are called conduit or accumulating distributions). The downside of doing this is the possibility of higher taxes and loss of IRA stretching. In essence, it is not advised.
As you can see, the rules involving an IRA and its distribution are very involved. It is recommended you meet with a professional advisor when it comes to IRA distributions and how to handle its transfer following the death of its owner. For that reason, be sure to talk with the attorney or financial advisor of your choice about your options.
This article is intended for informational use only and is not for purposes of providing legal advice or association of a lawyer – client relationship.
James W. Mallonee (Jim Mallonee) is a graduate with a B.A. degree from the University of South Florida and a Master of Science degree from Rollins College in Winter Park, Florida. He obtained his Juris Doctorate from the University of the Pacific, McGeorge School of Law in Sacramento, California. Prior to returning to Florida to practice law, Mr. Mallonee was employed by Intel Corporation for 22 years in such locations as New Jersey, Florida and California.
In addition to being a member of the Florida Bar since 2003, Mr. Mallonee serves on the Charlotte Community Foundation Committee for asset allocation and teaches Business Law at State College of Florida. Mr. Mallonee is also on the Board of Directors for the Military Heritage Museum located in Charlotte County, Florida.
His firm practices law in the following areas: Probate, Wills & Trusts, Guardianships, and Litigation in the areas of Real Estate, Guardianships and Estates. The firm has two locations in Venice and Port Charlotte, Florida.
James W. Mallonee, P.A.
946 Tamiami Trail, #206
Port Charlotte, FL 33953
Facsimile (941) 206-2224
871 Venetia Bay Blvd., #225
Venice, FL 34285