Minimizing Required IRA and 401(k) Withdrawals without Penalty Favors Annuity Purchase

Written by Hersh Stern Updated Friday, December 13, 2024

Keeping your 401(k) and IRA accounts intact until age 70½ is wise. It allows your money to grow tax deferred. Upon turning 70½, however, you must begin withdrawals. To keep them low, you can base them on the joint life expectancy of you and your beneficiary. However, you must choose one of three withdrawal formulas. The method you choose will make only a little difference early on, but it'll make a huge difference once you or your beneficiary dies.

The two most common methods are known as term certain and recalculation. (You can use recalculation only with your spouse as beneficiary.) But you may also choose a blend of the two known as the hybrid method.

Before you make a decision, keep these two points in mind:

(1) You must notify your IRA custodian in writing about which method you're choosing. If you don't, the custodian may choose one for you–almost always recalculation. If neither of you cites a preference, the IRS will assign you the recalculation method.

(2) Once a method is chosen, you're stuck with it for the rest of your life. Best advice: Make the decision yourself so that you can be sure it suits your long-term goals.Here are the benefits and disadvantages of each method:

Term Certain

You divide your retirement account balance by the joint life expectancy of you and your beneficiary. You must use the IRS mortality tables in Publication 590, available free by calling 800-829-3676 or on the Internet at http://www.irs.ustreas.gov. In each subsequent year, you subtract one from the previous year's divisor. For example, let's say you have an IRA worth $350,000, you're 70 and your beneficiary is 65. Since your joint life expectancy is 23.1 years, you divide $350,000 by 23.1; the answer, $15,152, is your minimum distribution for that year. The following year, you divide your account balance by 221. And so on.

Who benefits? If you feel that because of illness or heredity either you or your beneficiary stands a good chance of dying sooner than the IRS mortality table predicts, you ought to consider term certain, says Mike Rahn, a researcher with the IRA Reporter, an industry publication in Breanerd, MN. That's because the IRS will allow the survivor to continue to subtract one year from your joint life expectancy divisor each year as if the other were still alive.

Downside:

What if you live longer that the IRS predicts you will? Over the long run, term certain forces you to deplete more of your account than either of the other calculation methods. For example, if you're 70, your beneficiary is 65 and your tax-deferred account totals $350,000, over 10 years you'll have to withdraw about $206,978 in minimum distributions, assuming the account grows an average of 7% annually. That's about $8,174 more than if your were to use the recalculation method, described below.

Recalculation

In the first year, you compute your withdrawal as you would using term certain. The following year, however, instead of subtracting one from the divisor, you again use the IRS mortality tables to determine your joint life expectancy. For instance, in Year Two, our hypothetical couple in the previous example would have a joint life expectancy of 22.2 years.

Who benefits?

Retirees whose primary concern is withdrawing as little as possible from their accounts. As long as both of you are alive, this is clearly the best method, since you'll still have money in your account even after you turn 95.Downside: What if your beneficiary dies prematurely? Let's say you've been making mandatory withdrawals from an account that was worth $350,000 when your were 70½. When you're 80, your spouse dies at 75.

Using the recalculation formula, you'll be forced to refigure your annual withdrawals solely on the basis of your own life expectancy. The next year, when you're 81, you'll be forced to take out about $45,377 under recalculation, compared with $32,293 had you used term certain.

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Hybrid

This method uses the recalculation formulation but creates an artificial age for your beneficiary based on the IRS' tables. Sounds complicated, but it's all clearly explained in Publication 590.Who benefits? Retirees who want to withdraw as little as possible but would also like some protection against the possibility that their beneficiaries might die prematurely.

Downside:

Your withdrawals will be slightly higher than under term certain for the first few years. For instance, the couple in our example would withdraw a total of $208,640 over 10 years, vs. $206,978 under term certain. After the first decade, though, they'd begin withdrawing less each year than with term certain. In Year 16, for instance, they'd take out $41,348, vs. $43,512. The rule is, the older your beneficiary, the sooner you begin to see this method's benefits.