Albert Einstein supposedly remarked the hardest thing in the world to understand is the income tax. That may have been a quick quip back then. If he were around today and encountering the IRA distribution rules, he'd be dead serious.
Age 70 1/2 Confusion
Most are aware that a Minimum Required Distribution (MRD) must begin in the year in which the individual attains age 70 1/2. However, that first-year distribution can be deferred until April 1 of the following year. But if the taxpayer elects to defer, the second year will have two doses of income. Nevertheless, for retiring farmers with substantial grain deferral income, this flexibility can be helpful.
That Fictional Younger Spouse
The IRS table that dictates the MRD amount is quite taxpayer-friendly. It assumes each individual has a fictional 10-year younger spouse whose life expectancy is part of the computation. At 70 1/2, the first-year extraction is only about 3.7% of the account value. It's not until age 83 where the drawdown exceeds 6%.
Inheriting an IRA
The real complexity sets in following the death of the IRA owner. The first issue is identifying the designated beneficiary. If it's a surviving spouse, the preferential course is generally to have the survivor roll the IRA into his or her own IRA account. The surviving spouse then has the smaller MRD table that includes that fictional 10-year younger life. If the designated beneficiary isn't a surviving spouse, there are generally two choices. Assuming a younger beneficiary, the beneficiary's single-life expectancy in the year following death is used, and reduced by one each year thereafter. Alternatively, if the beneficiary is older than the decedent, the deceased owner's single-life expectancy in the year of death can be used.
If there are multiple beneficiaries designated, such as three children equally, the key is to first accomplish a transfer into an inherited IRA for each of the three, so that each can apply his or her own life expectancy to the annual withdrawals. If not separated, the oldest life applies for the MRD.
Inherited Roth IRAs
A Roth account is entirely after-tax. Allowing the account to grow as long as possible is very advantageous. Post-death, a surviving spouse may continue the deferral. If there is a non-spouse designated beneficiary, that person can stretch the distributions over his or her remaining life expectancy. But if no beneficiary is designated, the account must be distributed within the five-year period following death.
This is a condensed summary. For example, other rules can apply if death occurs before age 70 1/2. A key point is to have designated beneficiaries for each of your IRA accounts. And if you inherit an IRA, seek professional tax help to assure that all alternatives are fully considered.
Editor's Note: Andy Biebl is a CPA and tax principal with the firm of CliftonLarsonAllen LLP in Minneapolis with more than 40 years of experience in ag taxation, including 30 years as a trainer for the American Institute of CPAs and other technical seminars. He writes a monthly column for our sister magazine, The Progressive Farmer. To pose questions for future tax columns, e-mail AskAndy@dtn.com.
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