IRA – Your Biggest Asset - Or Your Biggest Tax Bill?

Monday 5/31/2004


Millions of people have IRAs.  Millions of IRAs are left to beneficiaries.  Millions of dollars of unnecessary income taxes are paid every year because IRA owners and beneficiaries don’t understand how to avoid four big mistakes .

Complex estate plans with all kinds of wills and trusts may be out the window when one of these IRA mistakes explodes.

Are you aware that your IRA is not controlled by your will?  Or your trust?  It is controlled by your beneficiary designation.  Do you have a copy of it?

Even though many IRAs have incorrect beneficiaries, once you know how to fix it, it can be done simply and without cost to you. 

One of the reasons so many mistakes are made is that folks have their IRAs spread all over the place.  There may be a rogue IRA out there – one you forgot about – that has a beneficiary mistake.  One problem is, there may not be one knowledgeable advisor who helps you watch them all.  When you have all your IRAs with one custodian or advisor the chances of mistakes diminish. 

What is an IRA custodian, you may be asking?  They are the designer of your IRA.  They are legally responsible for making sure the IRS year-end reporting and distribution reporting is done and that the IRA meets IRC guidelines.  A custodian can be a bank, a brokerage company or an insurance company. 

IRA custodians are not all alike.  Some are flexible in the planning they allow you to do under the tax code.  Some are not.  It is a good idea to find out what kind of custodian you have before it is too late and Uncle Sam ends up a major beneficiary of your Retirement money.


Tuesday 6/1/2004

Did you name your estate as beneficiary of your IRA?


In our continuing coverage of IRA mistakes we are considering the massive income taxes that the IRS can collect if you have made one of a half dozen beneficiary mistakes. 

I know you’d like to think your financial advisor is handling those details – but most do not fully understand the distribution and beneficiary rules. 

If you name no beneficiary – the estate is beneficiary by default.  Can that happen?  Sure.  You’re filling out a lot of papers and the form just doesn’t get filled out and sent to the retirement department.  Is that a problem?  It causes all IRA proceeds to be taxed at one time instead of allowing them to be spread out over the life of the beneficiary.  One rule of thumb with taxes is – defer them whenever possible and if possible plan so you don’t have to pay them at all.

How can you avoid taxes on the IRA?  One way is to carefully choose your beneficiary.  Are you planning to leave any money to a charity when you die?  Or to a nonprofit organization?  Maybe you’ve always wanted to be able to give more money to WCNY but really needed the income while living.  When you die, if your IRA beneficiaries are non-profits or charities, the taxes never become due.  Non-profits don’t pay taxes.  Plan to leave other assets that are not so heavily taxed to your kids and give the money the IRS would take half (or more) of to an organization who can use it all.

I’m just settling an estate where the beneficiary the adult child of the IRA owner. She was unaware of the existence of the IRA until just recently.  Unfortunately, her dad died in 2002.  Her ability to stretch out the taxes ended last year.  She’ll have to take the entire amount out and pay the tax in a lump sum.


Wednesday 6/2/2004

Warning: Don’t leave any balances in your qualified plans when you retire or change jobs. 


There are a lot of investment choice reasons for doing a tax free rollover from your pension to an IRA.  You have thousands more investment choices.  For your beneficiaries, the tax cost of leaving your qualified pension money with your former employer can be devastating.  Say you have a 401k balance of $300,000.  You like your former employer’s plan and you are familiar and comfortable with it so you just leave it there when you change jobs or retire. 

Then you die.  Your beneficiaries get to write out checks to the IRS and NYS for $140,000!  Is that what you want? 

The same thing happens if you are self-employed and have your own pension plan.  Many self-employed business owners just leave the pension plan in place rather than terminating it and doing a qualified rollover - generally not a good idea.  If you’re concerned about not being able to make contributions or defer required minimum distributions because you are 70 and still working, that may be a valid consideration.  Just be aware that your death could cause 40% to 80% of the retirement plan to be paid out in income and estate taxes the year after you die. 

It may make more sense to terminate the big plan, roll the money into an IRA and start another plan – perhaps a defined benefit plan – and get some bigger tax deductions that way.

Can you have too many beneficiaries?  Say you name your spouse and your kids as beneficiaries.  The tax rules are different for spouses and kids. If you have the wrong IRA custodian, they may not allow for a split to reduce or eliminate taxes. 

Even though it is recommended you use a single custodian or advisor for your IRA, having more than one IRA can be good planning.  If your spouse is younger than 59½ at your death, he or she will have to make some decisions about income from IRAs.  If the IRAs are in two pieces, one can be rolled and one can be kept in your name and used for income. 




Thursday 6/3/2004

Does your power of attorney have language in it to specifically allow IRA beneficiary changes?


Say you decide that all this IRA beneficiary stuff is too complex and you are just not going to bother with it.  When you become incapacitated, your trustees and beneficiaries will likely be taking a look at everything.  It’s a specialization with some lawyers – doing what could be called “death bed planning”.  The whole purpose of it is to take advantage of any possible tax reduction techniques. 

If that happened to you – you were incapacitated – do you have a recent power of attorney to allow your spouse or son or daughter to make beneficiary or custodian changes that could save your heirs hundreds of thousands of dollars?  Proabbly not.

It amazes me how many think they have all the bases covered – and then the family finds out there is a mess due to incompetent legal advice or incompetent financial advisor advice.

Did you name a trust as beneficiary?  That can be a good thing if it is a contingency that can be changed by your heirs. Over the past 4 years, IRA owners have seen their account balances dwindle – some as much as 70%.  If you haven’t left some flexibility in your estate plan and IRA beneficiaries, you may have an old plan that does not allow for the fact that your spouse now needs that money to live on.  It’s time to do a review – and perhaps get a second opinion.

Contingent beneficiaries.  Do you have any?  Some custodians will pay the money out to your kids if you and your spouse die without naming secondary beneficiaries. That probably won’t avoid problems with the IRS.  Your IRA must have “named” beneficiaries for them to be able to “stretch” the payments and taxes. 

An IRA/Pension review would be a good thing to do.


Friday 6/4/2004

IRA to charity – that’s my favorite.  Give the kids a big life insurance policy in trust and disinherit the IRS.


Most folks don’t like paying taxes very much.  That’s one big reason they have an IRA in the first place.  They deferred taxes while they were working – but now, does the tax-man have to be paid?  Not necessarily.

How much tax you pay has a lot to do with your personal value system.  If you are committed to leaving everything you own to your kids, the IRS is likely to be a major beneficiary of your hard earned dollars.  If you hate life insurance and never bought any – or cashed it in when you retired – your options may be limited.  Life insurance in an irrevocable life insurance trust is totally tax free to your beneficiaries.  No income tax.  No estate tax.  The IRS gets nothing.  Why don’t people use these trusts more?  I don’t know.  Maybe they need the cash value of their insurance for their own retirement income.  Putting it into a trust locks the cash value away.  Last to die insurance is surprisingly inexpensive in retirement.  You may be able to get a $250,000 or $500,000 policy for about $10,000 a year. 

Does that sound like a lot to pay?  If you are creating an assts for your kids that allows you to disinherit the IRS from receiving $200,000 or more, it should at least be considered. 

Some of us will outlive our kids – so becoming charitably minded would be a good thing.  Some only want to give the kids a certain amount when we die. Some of us just don’t have any kids.  Your IRA planning can’t be done in a vacuum.  Get someone to help you take a comprehensive look at what you have, where you want it to go and what your planning options are.

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