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How and when does money leave an IRA?
This material is intended as general information only and is not intended as legal or tax advice. Some of this information may be quite complex and we strongly suggest you consult with your advisor or tax professional based on your individual situation.
1 Adjusted Gross Income includes wages, interest, capital gains, income from retirement accounts and alimony paid to the taxpayer adjusted downward by specific deductions (including contributions to deductible retirement accounts and alimony paid by the taxpayer); but not including standard and itemized deductions.
RMDs, which represent pretax dollars and all earnings, are taxed as ordinary income. The portion of RMDs based on non-deductible contributions, if any, is tax-free. All distributions must include both taxable and nontaxable funds (if any) based on a pro-rata formula provided by the IRS. You are subject to this rule if any of your IRAs were funded with aftertax dollars. All RMD calculations treat you as owning one big IRA from which a pro-rata share of aftertax dollars, if any, must be withdrawn. If you are affected by this issue, please use IRS Form 8606 to report the split. Earnings are always taxable.If the full RMD is not taken in a given year, a 50% excess tax is assessed on the amount not taken. For example, if you were required to take $10,000, but only took $6,000, a 50% excise tax could be assessed against the $4,000 shortfall in addition to income taxes due.
Inherited from spouse:
If the IRA is inherited from someone other than a spouse, the options are more limited. If this is the case, you may leave the account where it is or make a trustee-to-trustee transfer (to change investment vehicle from one IRA trustee directly to another), as long as the IRA (called a "decedent IRA" or "inherited IRA") is established in the name of the deceased owner for the benefit of the beneficiary (you). For example, the account might be titled as follows: "Joe Doe, deceased, F/B/O Jane Doe, beneficiary."
A non-spouse beneficiary has the option to:
A Stretch IRA can be described as a distribution strategy for an individual IRA's beneficiary. The objective upon your death is to S-T-R-E-T-C-H the beneficiary's payments over a lengthy period of time in order to obtain favorable economic and/or tax results. Payment projections over 30 years or more are not uncommon. The beneficiary is usually your child or a grandchild, but may be anyone you choose. There can be no guarantee, however, that the second- and third-generation beneficiaries will continue the stretch strategy and could elect to liquidate the account at any time.
Someone may want to S-T-R-E-T-C-H their distributions because money in an IRA grows tax-deferred.1 The beneficiary effectively inherits a tax-deferred1 savings account. By spreading the payments over a significant number of years, tax-deferred1 compounding continues, and taxes on the payments may be minimized or at least disbursed over many years.
The regulations prohibit death distributions to extend beyond the period of the initial non-spouse beneficiary's life expectancy, not recalculated as they age.
Example: Martha dies and her daughter Angela is the beneficiary of her IRA. Angela is 50 years old and her life expectancy is 34 years. In other words, Angela would need to withdraw 1/34, 1/33, 1/32, etc., of the account beginning on or before December 31 of the year following Martha's death.
If Angela dies five years later at age 55 and Angela's beneficiary is her son Bob, Bob can continue taking distributions based on Angela’s reduced life expectancy (34-5= 29). If Bob were to pass away before the 29 years were over, he could pass on the IRA to his beneficiary until the original life expectancy of Angela goes down to one, when the remaining balance would be fully distributed.
Unless restricted by the terms of the beneficiary designation, Angela and, subsequently, Bob, in this example, could accelerate their payments (take more than the minimum), which could lower the ultimate amount and length of the distributions.
If Martha did not name a beneficiary, the IRA assets may have passed on to her estate, with accelerated distributions being required. Some custodial account agreements may establish a beneficiary ordering rule, such as spouse, children, parents, etc., which could determine the actual beneficiary in the event the account owner did not have a named beneficiary upon death. A Lord Abbett IRA has the estate as a default beneficiary if a beneficiary is not named.
It is also important to note that IRAs cannot be transferred via an account owner's will, unless the will had been named, prior to death, as the beneficiary or contingent beneficiary of the account and accepted by the custodian.
1 Income whose taxes can be postponed until a later date; examples include IRAs and 401(k) plan earnings.
Risks Involving the Stretch IRA Strategy
Withdrawals by the account holder or beneficiaries in excess of the required minimum distribution (RMD) will exhaust the account at a faster pace, reducing or eliminating the effectiveness of the stretch strategy. Distributions greater than the RMD could subject the payments to higher federal and, possibly, state income taxes. When investing assets, which will be used to Stretch IRA payments, the investor must be cognizant of any front-end or back-end sales charges that can reduce the assets available. During an extended period of declining investment returns, investors will experience income fluctuations that may cause additional withdrawals to be made that will exhaust the account at a more rapid rate. There can be no guarantee that a Stretch IRA strategy will be advantageous to your specific situation, and many of its benefits are based on current tax laws, which are subject to change. If these laws change, an investor’s ability to maintain estimated distributions may be affected. Lengthy distribution periods, much like those involved in a Stretch IRA, expose an investor to significant market risk.
Example: Barbara withdraws $30,000 from her IRA on March 1, 2012. If she returns the $30,000, or a lesser amount, by April 30, 2012, she has had use of the money and avoided any taxes or penalties on the amount returned. She cannot make another withdrawal, with the ability to return it, until March 2, 2013.
If Barbara had another IRA (or several including SEPs1 and SIMPLE IRAs2), she could make this 60-day withdrawal from each of them, at different times, use the funds as she wishes, and return them within the 60-day period.
Withdrawing funds from one IRA and repaying it to another IRA connects the second IRA to the first IRA for purposes of the 60-day rule. If Barbara had two IRAs and withdrew from one, but repaid the other on a timely basis, she would lose the ability to make a separate 60-day withdrawal/return from the second IRA until March 2, 2013, in this example.
You must recognize there can be significant taxes and penalties if the funds are not repaid, and larger withdrawals may be more difficult to repay.
A rollover cannot be repaid to a SIMPLE IRA unless the funds were withdrawn from a SIMPLE IRA, but SIMPLE IRA assets, if the SIMPLE IRA were at least two years old, could be returned to any IRA.
1 A Simplified Employee Pension Plan, commonly known as a SEP-IRA, is a retirement plan specifically designed for self-employed people and small business owners. When establishing a SEP-IRA plan for a business, the owner and any eligible employees establish their own separate SEP-IRA; employer contributions are then made into each eligible employee’s SEP-IRA.
2 A SIMPLE IRA plan is an IRA-based plan that gives small business employers a simplified method to make contributions toward their employee’s retirement and their own retirement. Under a SIMPLE IRA plan, employees may choose to make salary reduction contributions and the employer makes matching or non-elective contributions. All contributions are made directly to a SIMPLE Individual Retirement Account set up for each employee (a SIMPLE IRA). SIMPLE IRA plans are maintained on a calendar-year basis.
Please note: An IRA may involve the application of fees and charges to the investor.
Lord Abbett will waive (or otherwise pay) the yearly $10.00 custodial fee that would be charged each year on an ongoing basis to every new IRA account and, therefore, will not assess a custodial account fee effective in 2013 or any year afterward. Fund level fees and expenses are still applicable. Please see the current prospectus.