About to retire? Facing corporate downsizing? Been too successful in saving for retirement and now face a 15% excise tax? Nearing age 70-1/2 when mandatory distributions must begin and confused about the options and alternatives available to you? — These are just a few of the personal financial issues people must deal with today. Unfortunately, all too often we receive improper and/or incorrect advice as to how to make the choices that need to be made. And, if you don’t make well-informed choices regarding your financial future, you and your family may end up losing significant amounts of money! The three case histories that follow are designed to shed some light on some of the most common situations that arise.
Case History 1: Early Retirement
A 52-year-old man is “forced” into early retirement. He has $320,000 in pension assets and $160,000 in 401k assets. He has little, if any, new job opportunities, and his spouse works part-time earning $20,000 a year. This person needs immediate income — a minimum total of $50,000 a year. He needs to avoid a 10% penalty on pre-59-1/2 distributions, and he also needs to be able to change the distribution amount or eliminate the distribution in the future.
By taking advantage of one of the “exceptions” to the pre-59-1/2 distribution rules (“substantially equal distributions”), over a 5-year period or up to age 59-1/2 (whichever is later) this “retiree” can receive nearly $35,000 from his pension plan and 401k assets without incurring the 10% penalty. Beginning at age 59-1/2, he can modify the distribution in any way — increasing, decreasing, or even eliminating it at will.
Case History 2: Excise Tax on Excess Accumulations or Distributions
A 62-year-old man has a 62-year old spousal beneficiary, $1,600,000 in qualified plan assets, and $170,000 lifetime excise tax exposure. Not only does he need a smooth flow of income from his plan assets, but he also needs to minimize or eliminate any excise tax, minimize income taxes, provide maximum estate value, and mininize income taxes to his beneficiary.
Based on conservative assumptions and by waiting until age 70-1/2 to begin distributions, this person will certainly exceed the threshold amounts and be subject to the 15% excise tax. By beginning distributions today, as opposed to waiting, and by making the proper calculations, we can identify the proper dollar amount of distribution necessary to completely eliminate the excise tax and have a smooth flow of imcome. Then, shortly before age 70-1/2 when mandatory distributions become necessary, we make proper irrevocable elections to ensure the lowest possible income tax exposure, the maximum estate value for the beneficiaries, and a continued smooth flow of income. The key ingredient in this situtation is to have the proper elections made at the time that mandatory distributions begin.
Case History 3: Excise Tax on Excess Accumulations or Distributions
A 69-year-old man has a 69-year old spousal beneficiary and $315,000 in qualified plan assets. Both spouses are in good health. This man has other money and does not need income from his qualified plan assets. He does need to minimize income taxes, maximize estate value for his beneficiaries, and reduce taxes to his spouse upon his death.
By making the proper irrevocable elections from the menu of available selections, this man can take the lowest dollar amount of required distributions, thereby gaining the lowest income tax exposure, the gratest estate value for his spouse and other beneficiaries, and the lowest income tax exposure to the spouse upon his death. He can accomplish all of this and still maintain flexibility in the event he needs or wants more income. Remember, he is only taking the minimum distribution amount, and he can always take more. The irrevocable elections to be made in this situation based on the data collected are (A) joint life expectancy, (B) recalculate life expectancy of account owner, and (C) recalculate life expectancy of the beneficiary.