Distribution Planning Modified

If you feel as though Uncle Sam hasn't done anything nice for you lately, think again. In 2002, the Internal Revenue Service finalized changes in the rules governing mandatory distributions from IRAs, 401(k)s, and many other tax-favored retirement plans.

What hasn't changed is the basic rule that triggers mandatory distributions from retirement plans — that you must begin taking mandatory minimum withdrawals by April 1 of the year following the year you turn 70½. In succeeding years, you must take the minimum annual distribution no later than December 31. If you don't take your required distribution, you're subject to a 50 percent federal penalty tax.  Also, withdrawals from traditional IRAs, 401(k) plans, and most other tax-favored retirement plans are taxed as ordinary income and, if taken prior to age 59½, may be subject to an additional 10 percent federal tax penalty.

Using New Distribution Planning Rules

What has changed is the method by which those required minimum distributions (RMDs) are calculated. Not only are the new rules simpler, but RMDs can also be lower. That means if you don't need the money in your IRA, you can withdraw less, pay reduced current income taxes, and allow more of your retirement fund to build up on a tax-deferred basis. So if you're locked into a distribution schedule you don't like, you may be able to take advantage of the new lower distribution rules this year.

The new rules also offer more flexibility when it comes to naming and changing beneficiaries as well as calculating minimum withdrawals for inherited retirement accounts.

Previously, once you had reached age 70½, named your beneficiary, and calculated the mandatory minimum withdrawal amount for your account, your beneficiaries were locked into that same schedule until the value of the inherited account was exhausted.

Distribution Planning Gains Flexibility

Under the new rules, you can change beneficiaries at any time — in some cases even posthumously — and the RMD amount can be changed to reflect the life expectancy of your heir, again allowing more money to remain in the tax-deferred account.

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Whether you could potentially benefit from these changes depends on your particular situation. These sweeping changes to retirement accounts could have a substantial impact on your retirement income and estate conservation plan.