Retirement > 401(k)s & IRAs
Which IRA method fits?
July 26, 2000: 11:38 a.m. ET

How you distribute your IRA is the most important decision you'll make
By Ed Slott
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NEW YORK (CNNfn) - You must pick an IRA distribution method, but which one is best for you?

The answer isn't easy. There is the Recalculation method, the Term Certain method and the Hybrid method. And there are many variations of the three.

graphicThe stakes are high, because picking your distribution method is a key factor in determining how long your IRA will outlive you. Once you make your choice, it is irrevocable after your Required Beginning Date (RBD). The RBD for IRA owners is April 1 of the year following the year you turn 70 1/2 years old.

Here are some guidelines you can use to help you select the IRA distribution method that is best for you.

Some general thoughts when picking a method

Here are some rules that apply to all three distribution methods.

∑ The life expectancy is the same under all three methods for the first required distribution year.

∑ For IRAs inherited by a non-spouse, all three distribution methods work the same way for Roth IRAs as they do with regular (traditional) IRAs, except that Roth IRA distributions are tax-free (unless the account has not been held for the required five years). For the five years, the beneficiary tacks on the time the Roth IRA was held by the Roth IRA owner.

Read Ed Slott's recent columns on the three most important decisions you'll make with your IRA: Choosing a beneficiary; picking a life expectancy and picking a distribution method.

∑ If the spouse is the beneficiary, he or she can do a spousal rollover and treat the IRA or Roth IRA as his or her own, regardless of which distribution method is selected.

∑ For IRA or Roth IRA distributions, the minimum required distribution is not a limitation. IRA owners or beneficiaries can always withdraw more than the required amount if they wish, as long as there is no special restriction placed on the IRA by the IRA owner, for example, in a trust.

Dual recalculation

The advantage is your IRA will last the longest if you choose this method. Required distributions after the first year are lower than under the other two methods.

You will also never outlive your distributions, and this method produces the lowest required distributions. This method works best the longer you live, so if you are choosing dual recalculation, take your vitamins.

The disadvantage is the early death of the beneficiary accelerates distributions. If the spouse (beneficiary) dies first, the IRA must be withdrawn using only the IRA owner's remaining life expectancy. Then when the IRA owner dies, the entire account must be distributed by the end of the year following the year of death. A new calculation must be made each year.

Dual Recalculation is best for IRA owners whose primary concern is to withdraw the smallest amount possible and to have distributions last for the lifetimes of themselves and their spouses. This method is good for couples or individuals who have no children or who have beneficiaries whose tax consequences are of little concern to the IRA owner. For example, if your beneficiary is a distant relative or a charity. In this case you would not be concerned that after your death the entire IRA would have to be withdrawn.

Term certain

The advantage with Term Certain is it's the most simple and practical method. It is the easiest to implement. The payout term is not affected by death. It continues after death. It's only calculated once, for the first year.

The disadvantage is the IRA can be emptied if you live beyond the term. Distributions can end during your lifetime, but for most people that would not occur until you are over 90 years old. By then, I think it's time to stop accumulating for your old age and start spending some of it. Otherwise you'll be building a savings account for the government.

It also produces larger distributions in later years. In the final year of the payout term, the entire IRA balance must be withdrawn.

This method is best used for IRA owners who want a guaranteed distribution regardless if someone dies. †With Term Certain, your tax deferral period is set and will not be shortened due to an early death of the IRA owner, the beneficiary or any further beneficiaries. This method also works well for IRA owners who want to leave their beneficiaries the longest possible distribution period after their death.

However, under Term Certain, if the IRA owner outlives his life expectancy, the IRA will be fully distributed and there will be no IRA balance remaining for the beneficiary to inherit. Term Certain is also best if there is an early death (health problems or a short life expectancy), since the beneficiary will have more years over which to distribute the IRA.

Hybrid method

The advantage is required distributions in later years are less than with the Term Certain method. Required distributions are not accelerated when beneficiary dies.

The disadvantage is complex calculations make it difficult to work with. However, a computer can be used to calculate annual required distributions. Some financial institutions do not allow the Hybrid method.

If the IRA owner dies early, required distributions will be larger than under the Term Certain method. In early years the required distributions will be greater than under the Term Certain method.

It's a gamble. You are betting you will beat the life expectancy tables, and only half of us will do that!

This method is best used for IRA owners who want the best of both worlds. They want required payments to last for the longest period possible or for life, but also want to make sure that an early death of the IRA owner or the beneficiary does not cause the IRA to be paid out more rapidly, because they would still like the beneficiary to be able to extend required distributions over the remaining term after the IRA owner's death.

The Hybrid method, although a bit complex for most, accomplishes this, but not without giving up some of the pure advantages of both the Dual Recalculation and the Term Certain methods. With the Hybrid, you are betting you will outlive your life expectancy, which half of us will... we just don't know which half.

My recommendation

Elect Term Certain for both you and your IRA beneficiary. You cannot beat the guaranteed deferral period and it is so simple to use. It also works out better than the Recalculation and Hybrid Methods if your beneficiary dies early. Unless you have no concern about the tax consequences to your beneficiaries, or you have no beneficiaries, Term Certain is the way to go in all cases. No question about it. Back to top


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