April 1996 Bulletin

Beware of retirement excise tax

by Joel M. Blau

Joel M. Blau is president, MEDICUS Asset Advisors, Inc., an associate of AMA Investment Advisers, L.P.

Use caution when taking retirement distributions from your tax qualified plans. The Tax Reform Act of 1986 established a 15 percent excise tax on withdrawals from retirement plans which exceed certain limits. To determine if you are affected, you must include the total value of all distributions from qualified pension and profit sharing plans, Keogh's, 403(b) tax sheltered annuities, and IRAs. After tax employee contributions are not included in the calculation.

Generally, the 15 percent excise tax will apply to yearly distributions in excess of $155,000 for 1996. This figure can increase in the future as it is indexed for inflation. If you were to take a lump sum distribution, the excise tax will be on the amount in excess of five times the annual limit of $155,000 or $775,000.

Keep in mind that the lump sum excise tax applies only to a taxable distribution, not to a qualified rollover. With a rollover, you actually transfer your qualified plan, typically at retirement or termination of employment to an IRA. In this case, the excise tax will only apply when you begin taking taxable distributions from the IRA.

What makes matters more confusing is that some taxpayers utilized an irrevocable Grandfather Election on their 1987 or 1988 tax return. These individuals had accrued qualified retirement benefits in excess of $562,500 as of August 1, 1986. The election allowed for grandfathering of those benefits at the time and caused the portion of any distribution attributable to such accrued benefits to be exempt from the 15 percent excise tax.

A seemingly logical method of avoiding the excise tax altogether would be to simply limit your annual retirement distributions to the threshold amount. At death, your remaining balance would be distributed to your intended heirs. Unfortunately, the government was not about to allow taxpayers this generation skipping opportunity. If an individual dies before receiving their entire retirement benefit, an "excess retirement accumulation" tax may be imposed on that portion deemed to be excessive. To determine the amount to which the excise tax is imposed, a calculation is made. The 15 percent added tax is computed by taking the current value of all qualified retirement plans and subtracting the present value of an annuity payable for the life expectancy of the individual immediately before his or her death. The annuity is based on annual $155,000 payments, or the applicable annual figure if the grand-
father election is made. To make matters worse, the excise tax at death is in addition to the Federal Estate Tax, which has a top rate of 55 percent.

If the value of your retirement plan subjects you to the 15 percent excess distribution or accumulation excise tax, proper planning is needed. The use of various strategic estate and retirement planning techniques can help you minimize the effect of the excise tax over your lifetime, as well as at death.

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