Death and taxes: the IRS wants it before you go

by Marita L. Dreiling

for the Business Journal

Your dad called and asked for a favor. He meets once a week with his coffee buddies, and they were discussing taking distributions from their traditional individual retirement accounts (IRAs) and 401(k)s.

His friends told him they had to take the distributions in order to avoid a 50 percent penalty, even though they don't need the income to live on. Your dad wanted you to call your accountant buddy to see if this was true.

Surely your dad must have misunderstood. A 50 percent penalty is loan shark rates, and the Internal Revenue Service certainly wouldn't be in the same category as loan sharks. Surely the government wouldn't allow it.

A visit with your accountant verifies the information is correct. Between the ages of 59 1/2 and 70 1/2, a taxpayer can withdraw any amount from his traditional IRA or 401(k) as long as the tax is paid on the distribution. But by April 1 of the year following when you turn 70 1/2, you must either withdraw the entire balance or start taking periodic distributions.

The Internal Revenue Service's reasoning behind receiving distributions is simple they want the tax dollars on the deferred income.

In some circumstances, you should postpone taking distributions from tax-deferred sources as long as possible so the funds can continue to accumulate tax-free. The use of Social Security benefits and previously taxed income before withdrawing your 401(k) and IRA is a better tax-planning tool.

If the entire balance is not withdrawn, you will need to calculate the required minimum distribution. If the minimum distribution is not figured correctly, you can be hit with a 50 percent penalty for every dollar you should have taken out of the plan. And the calculation is a tricky one.

The distributions must be paid out during the life expectancy of the owner of the plan or the life expectancies of him and a designated beneficiary. The life expectancy of the designated beneficiary is treated as not being more than 10 years beyond the owner's life if the designated beneficiary is not his spouse.

The 10-year rule is another way the IRS will ensure you won't name your great grandson as the designated beneficiary, therefore prolonging the distributions. The IRS provides life expectancy tables in Publication 590 to help taxpayers figure their remaining time to pay taxes.

Because the plan continues to grow, a valuation amount must be determined for distribution purposes. The IRS guidelines are to use the valuation amount in the calendar year preceding the year distributions are received.

It you have more than one plan (for example, two traditional IRAs and two 401(k)s), one minimum distribution amount is based on the total of all the IRAs. Another calculation must be figured for each separate 401(k). Then you can take the distribution from one IRA in total or a combination of accounts, as long as it's the required minimum. But the minimum distribution on the 401(k) must be withdrawn from each individual 401(k) account.

In summary, the IRS wants you to estimate two dismal issues when you're going to die and how to make sure you pay enough taxes while you're alive. This is not a cheerful scenario. Once again, the only things in life that are certain are death and taxes, and the IRS wants you to tell them when and how much,

(Marita L. Dreiling is a CPA with Kirkpatrick, Phillips and Miller, CPAs, in Springfield.)