by Archie M. Richards, Jr., CFP^®
July 30, 2001

Out of the goodness of its ever-loving heart, the IRS has made life easier for people who are required to make taxable distributions from IRAs and 401(k) Plans.

Contributions to traditional IRAs, as you know, are deductible. The pols lose money at the front end; they want some of it at the rear. Withdrawals from IRAs must start no later than April 1 (not April 15) of the year following the year in which the owner turns 70 1/2. (Don't you just love tax language?)

But the amount required for distribution is considerably less than prevailed under prior rules. You no longer need to compute the amounts yourself; IRA trustees are now required to advise how much to distribute.

The required annual distributions are based on an IRS table of life expectancy which assumes that the distributions are paid jointly to you and to someone ten years younger than you. Even though the payments would actually go to you alone, the assumed younger person extends the payout period. The distributions are therefore less, and so is the tax. Nifty, eh? The same payout level prevails even if distributions are made instead to an older person or a much younger person.

If the payments are made to you but your spouse is more than ten years younger than you and is named as the sole beneficiary of the IRA after your death, an even more-favorable payout schedule applies.

Nothing prevents you from withdrawing more than the required amounts. This increases the tax, but naturally, if you need the money, you need the money.

Okay, after the required payments have begun, let's say you die. Your beneficiaries have until December 31 of the year after the year of your death to decide how they will treat the IRA. They may leave it in your name and take out distributions based on their own life expectancies (the life expectancy of the oldest beneficiary prevails for all). They may disclaim their shares. They may cash out their portion and pay the resulting taxes. Or, they may divide the IRA into separate shares.

Let's explore that disclaiming business. Assume you have a IRA worth $600,000 and designate your wife as beneficiary. You name your two children as first alternate beneficiaries and your four grandchildren as second alternates. All beneficiaries may disclaim.

After you kick off, you wife (tearfully, of course) rolls over $200,000 to her own IRA. The other $400,000 she disclaims, causing those funds to pass automatically to the children. Let's say that each of the two children retain $100,000 for themselves and disclaim $100,000.

The four grandchildren now share $200,000, each one having an IRA worth $50,000. Assume that one of them is only five years old. With such a long life expectancy, she is required to withdraw only 1.3 percent of the value each year.

Assume that the granddaughter's IRA grows at 10 percent a year. After the 1.3-percent withdrawals, the account nets 8.7 percent (10% less 1.3%). Eleven years later, the IRA is worth $125,000. This would help a lot for college, even after paying the tax.

If the funds are not used for education but continue growing at 8.7 percent net, the $50,000 in thirty years would be worth $600,000. The granddaughter might want to start a business at about that time. The money would come in very handily indeed.

Despite the favorable new rules, IRAs are still ridiculous loopholes. They aid the middle class, who pay income taxes, but not the poor, who don't. IRAs enable politicians to appeal to as many people as possible. To disadvantaged voters they boast about the high tax rates on the wealthy. To middle-class and wealthy voters they boast about loopholes such as IRAs that reduce the taxes.

But there's this teeny little problem: Tens of thousands of loopholes have accumulated, turning the tax code into a snake-filled swamp.

Limiting the number of terms legislators can remain in office would reduce the proportion of professional politicians. Citizen politicians could then lower the tax rates, discard the loopholes, and not care if they get voted out. Am I talking sense, or what?