Questions on IRAs, pensions

Readers have been asking a lot of questions about the pension bill President Bush signed this month, which is not surprising since it's more than 900 pages long.

I'll answer a few today, starting with this query from "Anybody."

"I own a Roth IRA, and I've named my son as beneficiary. Under the old law, I'm not required to take distributions from the account, but my son will be required to take distributions once he inherits the account. From what I've heard, that may or may not have changed. Under the new law, will my son be required to take distributions from my Roth IRA once he inherits it or will he be able to allow the money in the IRA to grow indefinitely?"

The law regarding inherited IRAs has not changed. When you inherit an IRA from someone other than your spouse, you must begin taking distributions. You can spread them out over your life expectancy or over a shorter period if you wish. This applies to both regular and Roth IRAs. However, with a Roth IRA, the distributions generally will be tax free, says IRA expert Ed Slott.

The law does provide a big benefit for people who inherit a 401(k), 403(b) or other workplace retirement account from someone other than a spouse. This is probably what Anybody heard.

Under the old law, if you inherited a 401(k) account from a non-spouse, you did not have the option of rolling it into an IRA.

If the plan forced you to take a distribution, you had to take the money and pay taxes on it. Most plans do force heirs to take distributions, although some let you spread it out over as many as five years. The old law resulted in large, unexpected tax bills for many non-spouse beneficiaries such as children or domestic partners.

A spouse, on the other hand, could roll an inherited 401(k) plan into an IRA and spread the distributions, and the tax bill, over his or her life expectancy. Under the new law, anyone who inherits money from a 401(k) or other workplace plan can have it transferred directly to a "properly titled" IRA and preserve the tax benefits, Slott says. You must set up a separate inherited IRA to receive the proceeds.

The new law applies to distributions made after the end of this year from 401(k) and other workplace plans. For more on this and other IRA-related provisions, go to www.irahelp.com and click on Pension Protection Act of 2006.

Walt C. had a question about my Aug. 11 column, which said most people who take lump-sum distributions from their defined-benefit pension plans will get slightly less starting in 2008.

To calculate the lump sum, companies must use a certain interest rate. The lower the interest rate, the higher the lump sum and vice versa. Under the old law, companies had to use the 30-year Treasury bond rate. Under the new law, they will have to use a rate that reflects the yield on corporate bonds of various maturities. Because corporate bonds generally yield more than Treasury bonds, the rate switch, by itself, is expected to result in smaller lump sums for most people.

Walt wants to know: "How is this interest rate calculated? I assume it is a long-term average."

The answer is no. The rate is calculated at a single point in time.

Today, the rate is based on two things, determined in advance by each company, according to John Parks, secretary/treasurer with the American Academy of Actuaries.

The first is the so-called stability period, which could be anywhere from one month to one year. Anyone who retires during the same stability period will get the same rate. The second factor is the look-back period, which is typically two to three months before the stability period begins.

Suppose the stability period is one year and the look-back period is two months. That means anyone who retires in 2006 would have their lump sum calculated using the Treasury bond rate as of Nov. 1, 2005, says Parks.

Starting in 2008, the interest rate will still be a spot or one-day rate. But instead of using the yield on a single maturity (the 30-year Treasury bond) it will be a blended rate based on short-, medium- and long-term corporate bonds. "It will consist of three segments: bonds of less than five years, five to 20 years and over 20 years," says Parks.

Your rate will be based on your age. Younger retirees will have more long-term yields incorporated in their calculation, because they are expected to live longer. Older retirees will have more short-term yields incorporated. Because long-term bonds usually yield more than short-term bonds, the younger you are at retirement, the smaller your lump sum.

Parks says it would be foolish to base your retirement date on interest rates because they change constantly and are unpredictable.

The impact of the rate change will be muted because it will be phased in over five years starting in 2008. Also, the impact will be softened by the adoption in 2008 of new life expectancy tables, which, by themselves, will result in bigger lump sums.

(E-mail Kathleen Pender at kpender@sfchronicle.com.)

(Distributed by Scripps Howard News Service, www.scrippsnews.com.)

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