We all thought it would be too good to last, and it was. With 2010 came the return of the required minimum distribution, or RMD. Required Minimum Distributions (RMDs) generally are minimum amounts that a retirement plan account owner must withdraw annually starting with the year that he or she reaches 70 ½ years of age, or the year in which he or she retires. However, if the retirement plan account is an individual Traditional IRA or the account owner is a 5% owner of the business sponsoring the retirement plan, the RMDs must begin once the account holder is age 70 ½, regardless of whether he or she is retired. In general, all of the tax deferred Employer-Sponsored Retirement plans such as the 401(k), 403(b), Rollover IRAs, SEP IRAs, and Traditional IRA’s are subject to required minimum distribution rules. Roth IRAs are not subject to RMD rules, and the exemption also applies to most Section 457(b) deferred compensation plans maintained by state-level government agencies. There is also a required minimum distribution requirement for beneficiaries who inherit retirement assets, such as those listed above, where a RMD is mandated.
Generally, a RMD is calculated for each account by dividing the prior December 31st balance of that IRA or retirement plan account by a life expectancy factor that the IRS publishes in Tables in Publication 590, Individual Retirement Arrangements (IRAs). There are three separate tables as listed on the IRS website, www.IRS.gov:
- The Joint and Last Survivor Table is used by an account owner whose sole beneficiary of the account is his or her spouse and is more than 10 years younger than the account owner
- The Uniform Lifetime Table is used by account owners whose spouse is not the sole beneficiary or whose spouse is not more than 10 years younger; and
- The Single Life Expectancy Table is used by a beneficiary of a retirement account.
One of the purposes of a required minimum distribution is to prod retirees to use the money they’ve set aside for their retirement years, and not leave most of it behind as part of their estate. Very simply, the government would like to collect some revenue on all of this money that has been saved and invested on a tax deferred basis. Requiring retirement account owners to withdraw assets generates tax revenue for the government. And in these days of high government debt obligations, it’s probably fair to say that the government would like to collect all the revenue it can!
Of course, these required distributions are yours to do with what you will. The IRS only wants the money to come out and be taxed. What you do with it is up to you. You can use it to supplement your living expenses in retirement, or if these funds are not needed for that purpose, many of our clients use these funds to make annual gifts to children, grandchildren (education funding such as in a 529 may be a good idea) or the charitable organizations that mean the most to you. Another strategy which has become more prevalent as a means of utilizing RMD distributions to create wealth for the next generation is to use some of the money to fund a permanent life insurance policy.
If the required minimum distributions are not necessarily needed for living expenses, they can be put to use to help fund an insurance policy that can serve as a legacy for the next generation. Why, you may ask, would someone want to do this? It generally comes about as a strategy for helping to pass along assets to the next generation in an easier and more efficient way. Of course you can name beneficiaries on your retirement accounts, But in most cases those beneficiaries may inherit the assets with tax consequences, i.e. the income tax generally due on retirement account withdrawals as they are made, as well as the possibility of inheritance tax depending on the situation. Sometimes it may be more desirable to use a life insurance policy to make a smoother transition of assets to children or grandchildren. Instead of the tax issues surrounding inherited retirement account money, a person can use a life insurance policy to pass along assets, generally tax free, to children or grandchildren. This can make for a much cleaner and smoother transition when legacy planning for the next generation.
Of course we always need to understand the situation in its entirety, as not all strategies are right for everyone and sometimes making a smooth transition of assets to the next generation is not a person’s top priority. There may be other considerations in an individual’s life and personal situation that take precedence over legacy planning. Be sure to talk to your advisor about legacy planning to understand what may be best for you.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Gregg Daily is Vice President and Financial Advisor at Fragasso Financial Advisors, a Pittsburgh-based investment and financial planning firm. Due to industry regulations, comments are not permitted on this blog. If you would like to contact the author, please email us at blog@fragassoadvisors.com. Gregg can also be reached for comment at 412-227-3200.