Help Your Clients Avoid an Excise Tax of Up to 50%

The IRS can charge an excise tax of up to 50 percent if clients don't take the Required Minimum Distribution (RMD) from their IRA accounts or Qualified Retirement Plans by April 1 of the year after the year they turn 70.

In other words, if the client turns 70 1/2 in 2007, they need to take the RMD by April 1, 2008. Even if they start taking distributions earlier, once they turn 70 1/2, they need to make sure that the distributions for that year and future years meet the IRS minimum requirements.

The minimum distribution is based on the account balance divided by remaining life expectancy or by the applicable distribution period. This amount needs to be recalculated every year to reflect changes in the account balance (for example, rising or falling stock or bond prices).

Example

Edna, date of birth is May 6, 1937, is required to take her first IRA distribution by April 1, 2008. If Edna takes her distribution in February 2008, she will take two distributions in 2008; one for 2007 based on her 2006 account balance and her 2008 distribution based on her 2007 account balance. Assuming her 2006 account balance is $135,000 and her 2007 account balance is $132,000, her February distribution would be $7,941 based on a 17 year single life expectancy. Her 2008 distribution which would be required to be taken by 12/31/08 would be $8,098 based on a 16.3 year life expectancy.

There are a couple of planning opportunities for Edna:

1. Consider taking her first distribution in 2007. This will allow her to spread the taxable distributions over two tax years.
2. If she doesn't need the income, she could gift the 2007 distribution amount to a qualified charity. This distribution is not taxable to her in 2007 and it meets the requirements for her distribution. This alternative is only available for 2006 and 2007 tax years.
3. If her Adjusted Gross Income (AGI) is below $100,000 for 2007, she could convert the IRA to a Roth IRA. Although the 2007 required distribution would still be taken from the IRA prior to conversion, the future Roth IRA is no longer required to have distributions made annually. Edna would pay income taxes on the converted amount in 2007, however, this strategy allows her to provide an income tax free inheritance to her beneficiaries. If Edna's AGI is above $100,000 she can convert the IRA to a Roth IRA in 2010 when the $100,000 income limit is removed.

In this example, if Edna did not take her distributions timely, she would be penalized 50% on the amount not withdrawn. For 2007 the penalty amount would be $3,970 and the penalty for not taking the 2008 distribution would be $4,049. This penalty is reported on IRS form 5329. To avoid this situation, establish an automatic distribution on the IRA account.

For Clients with Annuities Inside an IRA or Qualified Plan

In the past, RMDs for qualified accounts were calculated solely based on the prior year's December 31 account value. The IRS has adopted final regulations requiring changes in the methodology used for calculating RMDs for annuities beginning in the calendar year 2006 and forward. Pursuant to the new regulations, RMDs will be based on the "entire interest" in the annuity contract. (See Treas. Reg. 1.401(a)(9)-6.) These regulations define the "entire interest" as the prior year's account value plus the actuarial present value of any additional benefits provided by the annuity contract. For these purposes, any "additional benefits" generally will include most living benefits, withdrawal benefits and some death benefits.

Since the RMD calculation is essentially based on a present value of the additional benefits in most cases the RMD will only be slightly higher than in the past, and in some cases, may be moderately higher. Those contracts most affected will be those with a higher death benefit in proportion to contract value. Remember, this only affects those annuity contracts that are held in qualified accounts that must pay an RMD, such as a traditional IRA, a 403(b) or a 401(k) or those that are in settlement where the beneficiary has elected "stretch."

For Clients who Don't Need the Cash-flow

Your clients originally invested in tax-deferred assets such as annuities and IRAs to help create a strong retirement savings plan. As they grow older and more affluent, their potential income and estate tax exposure becomes a bigger problem than their retirement planning needs. Some may no longer need these assets for income purposes.

At their death, a tax dilemma is created because these assets will be subject to both income and estate taxes. In fact, they could shrink by up to 60-70% before reaching the beneficiaries. There is a wealth transfer planning strategy designed to enable your clients to pass on more of their wealth to their beneficiaries. With certain assets, by addressing the income taxes during their lifetime along with the estate tax implications, beneficiaries can receive more wealth without the burden of these taxes. Because of life insurance's tax advantages, a properly structured life insurance policy will transfer money more efficiently, offering more attractive financial results to the beneficiaries.