Demystifying IRA Distributions

By David Chazin

For most of us, the big worry about retirement planning is building a sufficient nest egg. With the proper planning, and the benefit of Chevron’s ESIP match, many Chevron employees are able to build up sizable assets over their careers. It may be that the trickier part of IRA’s and 401(k)’s isn’t putting money into it—but taking money out.

Most Chevron employees probably know the basic rules of withdrawing from a traditional IRA or 401(k). They know they can begin taking distributions after age 59½ without any penalty. They know IRA’s are taxed as ordinary income at the state and federal level. A lot can go right when a distribution is handled properly. But plenty can also go wrong when it’s not.

There are a number of moving parts that can create not only confusion but opportunities for mistakes. Case in point: While you can withdraw as much as you like after age 59½, failure to take the required minimum distribution (RMD) after the year you turn 70½ has huge consequences—a 50% tax penalty on the amount that should have been withdrawn. (The RMD is calculated by dividing the adjusted account balance as of Dec. 31 of the previous year by the appropriate life expectancy factor based on the IRS’ Uniform Lifetime Expectancy Table.)

Let’s look at a Chevron retiree who turned 70 in 2009 and 70½ in 2010. They would be required to take a distribution no later than April 1, 2011 based on the account’s value ending Dec. 31, 2009. But this year they also must take a second distribution for the amount as of Dec. 31, 2010. So if you wait till April 1, typically you are required to take two distributions, which could push you into a higher tax bracket, especially if you’re also exercising stock options.

Three common pitfalls that you should avoid through sound distribution planning include the following:

Get the beneficiary right. Without a designated beneficiary, such as your spouse, kids, other people in your life, a trust or a charity, all money in an IRA or 401(k) must be distributed to the estate. If you haven’t checked your beneficiary designations lately, you should check with Chevron HR or Vanguard to ensure they’re in place. In addition, you may wish to discuss the various distribution options available with your intended beneficiaries.

If your beneficiary is a trust, be sure it qualifies under IRS regulations, such as the following: the trust must be valid in the state in which you reside; the beneficiary must be “identifiable” in the language of the trust; and, the trust must be irrevocable no later than your death.

Avoid the penalty for early distributions. Withdrawals taken before age 59½ typically come with a 10% IRS penalty. But there are some noteworthy penalty-free exceptions with only income taxes due, including distributions for higher education expenses (tuition, books, supplies, special needs services) for you, your spouse, child or grandchild; qualified medical expenses; $10,000 toward your first-time home purchase; “Substantially Equal Periodic Payments,” (72t) in which payments based on your life expectancy are spread over 5 years or to age 59½, whichever is longer; and health insurance premiums in the event of you leave Chevron.

Anticipate tax consequences. Generally, there’s no estate tax due when the death of the first spouse occurs, as long as the other spouse is noted as the beneficiary. A younger spouse will often be able to defer taking a distribution, and its resulting income taxes, by rolling over the plan to their own IRA. Additionally, non-spouse beneficiaries, including unmarried domestic partners, can now take RMD’s based on their life expectancy, rather than having to take distributions within five years or as a lump-sum payout. This saves tremendously on tax consequences, and allows the assets the potential to continue to grow.

Remember NUA. Because Chevron’s match is in the form of Chevron stock, Chevron employees are able to take advantage of a strategy that allows you to drastically reduce your taxes on this portion of your ESIP. There are a series of steps involved and you only get one shot to accurately complete them, so you should definitely speak with someone who is experienced in these matters.

We’d be happy to arrange a meeting with you to review your IRA/401(k) distributions and the NUA strategy, whether retirement is tomorrow or 15 years out. Because we work with many Chevron executives, managers, employees and retirees, we're very knowledgeable about your various compensation plans and benefit offerings, plus other issues specific to Chevron employees (in addition to the retirement, investment, and estate planning issues everybody faces). In fact, chances are you may know one of our Chevron clients and you can ask them how working with an advisor has helped them.

Please contact us at (925) 659-0217 with specific questions or to schedule a time to meet in our San Ramon, Point Richmond or Houston, TX offices. Also, follow us on LinkedIn.

David Chazin, Insight Wealth Strategies and Lincoln Financial Advisors Corp are not affiliated with Chevron.