Saving Money With Your IRA

The first rule of saving money with your Individual Retirement Account is that you want the tax deferral to work as long as possible. Every year you keep it going, you get to use money that would otherwise go to the Internal Revenue Service; a kind of interest-free loan from the tax collector. There are exceptions to this rule for high-net-worth savers threatened by the 15% penalty tax on large IRAs, but the keep-it-going ruleworks for most people most of the time.

The second rule of saving money with your Individual Retirement Account is that you have to be knowledgeable and determined to get the maximum benefit out of the first rule. The IRS makes it hard, of course; it wants to collect tax on the income bottled up in an IRA sooner rather than later. Some IRA sponsors seem as if they are aligned against you, too. They should be working for you but, through ignorance or orneriness, they stand in your way.

If you fit into this category of IRA savers that we will define below, then you should check out this technique that can help your IRA last longer. If you do fit in, make sure the bank, insurer or fund company holding your IRA will let you use this technique; switch sponsors if it won't. Citibank is among the IRA sponsors that don't allow it, whereas Fidelity, Merrill Lynch and Vanguard say they do.

You belong in this category if:
  1. You are the owner of a large IRA and are approaching the date (the Apr. 1 after you turn 70 l/2) in which you are required by law to begin taking payouts.
  2. You're the same age as or older than your spouse and likely to die younger.
  3. You want your spouse to inherit your IRA after your death.
  4. You want to minimize mandatory payouts and don't want to outlive your IRA.
  5. Apart from the actuarial facts of life alluded to in proviso No. 2, you can only guess whether you or your wife will die first. That is, neither of you has a family history or medical condition that makes predeceasing the other extremely likely.
  6. Notwithstanding your efforts to understand the tax code, you are not yet ready to be committed to an insane asylum.

If you fall into this category, then you should, when setting up your IRA payout schedule, seriously consider choosing a "hybrid" life. That sounds like actuarial mumbo jumbo, and it is. But it could give your IRA years of additional life, and that could make your family thousands of dollars better off.

Here's why: Before that Apr. 1 deadline you, the IRA owner, must make certain irrevocable choices that determine the schedule of required minimum payouts. One is whether to take payouts based on a single or joint life expectancy (click below for tables). This is easy: Choosing a joint life based on your age and that of heir(s) will always lower required payouts, giving greater flexibility. As we said, you can always take out more than the minimum if you need the money.

A tougher choice is between a recalculated life expectancy method (RLEM) and a fixed term life expectancy method (FTLEM). With a recalculated life expectancy, your life expectancy is refigured annually. Most people choose it because then it's impossible to outlive your IRA and it yields the lowest required payouts.

For example: IRA OWNER Jack is 70 and his wife, Diane, is 66. Their joint life expectancy using the RLEM is 22.5 years. Minimum initial withdrawal from an account worth $225,000: $10,000. If they are both alive a year from now, their remaining joint life expectancy is 21.7 years, and they use that number to calculate how much to withdraw then. Assuming the IRA has grown to $260,000, they should take out $12,000.

But RLEM has a drawback. All is well as long as Jack dies first, because then Diane can claim the account as her own, name new heirs and leave a "stretch-out" IRA that survives for many years after her death. The problem comes if Diane dies first. At that point, all of the remaining IRA funds must be paid out and taxed in the year after Jack dies.

What about using FTLEM? In that case, the ages 70/66 starting life expectancy of 22.5 years would be frozen. The IRA would die in 2019. Here the problem is that it is possible for Jack to outlive the IRA, and few owners want to chance that. Its advantage, however, is that the IRA can survive for the full fixed term even if both owner and spouse are dead. In some cases, this makes a big difference.

What to do? What most IRA owners;and many IRA sponsors;don't know is that you can choose a third method. It is a hybrid life expectancy, combining RLEM for one spouse with a FTLEM for the other. If you don't know who will die first, this is the way to go: Choose RLEM for the owner and FTLEM for the spouse.

Back to our example, Jack and Diane: Because Jack wants Diane and, after her, their children, to inherit the IRA, he chooses a RLEM for himself and a FTLEM for Diane. This way, they cannot outlive the IRA and they can defer their income taxes for as long as possible.

If Jack dies first, Diane can claim the IRA as her own, name the children as heirs and begin payouts based on her joint life expectancy with them. After her death and the payment of any estate or 15% penalty taxes, the children can receive IRA payouts, perhaps for decades.

And what if Diane dies first, say at 72? Even if Jack dies shortly afterward, the IRA can live on, like a ghost, for the rest of her fixed term;in this case, until she would have been 85 years old. (This is also what would happen if they died simultaneously.) Although that's not as good as if the death order were reversed, it's far better than nothing.

How do you get this kind of hybrid life expectancy method for my IRA? Contact us at Advanced Corporate Planning. We will find the most appropriate sponsor for you who allows it.

Then you'll need to do two more things. One is to mail a statement to your sponsor before that Apr. 1 deadline, declaring that you plan to figure mandatory payouts based on a hybrid method. The other is a table showing just what fraction of your IRA to withdraw, year by year. (It will be slightly higher than if you use RLEM, and lower than if you use FTLEM.) Such a table must be customized, based on your age and your spouse's. Ask us at Advanced Corporate Planning, your local pension plan expert, to compute the table for you.

 

NOTE: ALL information contained in this site is for illustration purposes only, and by NO means should be considered individual tax or legal advice under any circumstances whatsoever!

Lynn R. Siewert AIMC
Pension Consultant |  Branch Manager
CA Insurance License #00B00579
2005 E. Evergreen Blvd
Vancouver, WA 98661
Ph: 360-750-9626

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