New IRA Rules Affect Beneficiary, Distribution Tables and Trusts
Almost every plumbing and HVAC contractor I have spoken to in the last 14 years has some kind of pension or profit sharing plan or IRA set up at his company. The tax deductibility of these plans have made them a "must do" in the minds of their CPAs and rightly so.
Also, for many of these contractors, the value of their IRA, along with their home and business is one of the three largest assets they own. In fact, it is not uncommon for me to run across contractors who have more than $1 million in retirement accounts.
Unfortunately, the last 14 years have seen so many changes in the laws that the plans have become much more confusing. In fact, the plain old IRA has morphed into a deductible IRA, a rollover IRA, a nondeductible IRA, a Roth IRA, a spousal IRA, an education IRA and the SIMPLE IRA.
New RulesCongress is set to approve new IRA distribution rules, and I'm happy to report that these rules will make life easier for all of you. In order to understand and appreciate the new rules, it's important to understand how IRAs have worked for the last 15 years.
Under the old IRA rules, a person had to begin taking distributions by April 1 in the year following the year they turned 70 1/2 . For money coming out of a pension, the employee had to begin taking distributions at the same time, unless they were still working, in which case they could continue to allow the monies to grow tax deferred. (Of course, if you are the business owner and are still working, you must begin taking the money at age 70 1/2-Congress wouldn't want to cut you any slack).
BeneficiaryMost people are aware of these distribution-timing rules, and they have not changed. However, there was a very complex and strict set of rules for who the beneficiary could be, and the tax treatment could be brutal if you made the wrong choice. Under the old rules, when you turned 70 1/2 and started taking distributions you faced a deadline for choosing your final beneficiary. If you didn't have an individual named as beneficiary, when you died your IRA was considered liquidated, and your estate had to pay income tax on the full amount in the plan.
Most people would choose their spouse as beneficiary, and they would choose a distribution schedule that was based on either the husband's life expectancy, or a joint life expectancy of the husband and wife. Once this was selected, it was carved in stone for all intents and purposes. If one spouse died and the other spouse remarried, it was very difficult to change the amount that was being taken out every year.
If a spouse died and the surviving spouse wanted to leave the IRA to their children, the kids would have to pay a lump sum tax, or they would have to take the distributions on the schedule set up by the parents.
The new regulations have eliminated most of these problems. The first significant improvement is that a person can now change their beneficiary after age 70 1/2 without penalty in terms of the required minimum distribution amount. The new rules even allow the change of beneficiary to be recognized up until December 31 of the year following the account owner's death. In other words, not only can the owner change beneficiaries while they are alive, but their executor or trustee can change the beneficiary after death if it would make sense for estate tax planning.