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Help Beneficiaries Avoid IRA Mistakes

Help Beneficiaries Avoid IRA Mistakes

While annual contributions to IRAs are still relatively modest, the ability to roll over 401(k) balances to an IRA can result in significant IRA balances. Thus, in addition to retirement planning vehicles, IRAs are becoming estate planning tools for individuals who won’t use the entire balance during their lifetimes. If you are in that situation, help your beneficiaries avoid these common IRA mistakes:

Using the IRA balance too quickly.

After an IRA is inherited, a traditional deductible IRA still retains its tax-deferred growth, and a Roth IRA retains its tax-free growth. Your beneficiaries’ goal should be to extend this growth for as long as possible. If the IRA has a designated beneficiary that includes individuals and/or certain trusts, the balance can be paid out over the beneficiary’s life expectancy. Spouses have additional options that can stretch payments even longer. Your beneficiaries can also elect to take the entire balance immediately, paying any income taxes due. You should stress the importance of taking withdrawals as slowly as possible.

Not splitting the IRA when there are multiple beneficiaries.

When there are multiple beneficiaries, it is typically best to split the IRA into separate accounts by December 31 of the year following the original owner ’s death. If the account is not split, distributions must be taken by all beneficiaries over the life expectancy of the oldest beneficiary. By splitting the IRA into separate accounts, each beneficiary can take distributions over his/her own life expectancy. This is especially important for a surviving spouse, who can only roll over the IRA to his/her own account if he/she is the sole beneficiary. With the rollover IRA, the surviving spouse can name his/her own beneficiary, thus extending the IRA’s life and can defer distributions until age 70½. When other than an individual or qualifying trust is named as one of the beneficiaries, the IRA must be distributed within five years when the owner dies before required distributions begin, or over the owner’s life expectancy when the owner dies after required distributions begin. Separating the account or paying out the non-individual’s portion then allows the individual beneficiaries to take distributions over their life expectancies.

Rolling the balance over to a spouse’s IRA too quickly.

Once a spouse rolls over the balance to his/her own IRA, some planning opportunities are eliminated. While the IRA balance can typically be spread out over a longer period when the balance is rolled over, the spouse may need distributions. Spouses under age 59½ can take withdrawals from the original IRA without paying the 10% federal income tax penalty. Once the account is rolled over, withdrawals before age 59½ would result in a 10% tax penalty. Also, spouses who are older than the original owner can delay distributions by retaining the original IRA. The surviving spouse is not required to take distributions until the deceased spouse would have attained age 70½, even if the surviving spouse is past that age. The spouse may want to disclaim a portion of the IRA, which must be done within nine months of the original owner’s death. If the account is rolled over, that disclaimer can’t be made. Thus, it is typically best for the surviving spouse to determine his/her financial needs before rolling over the IRA balance.

Not properly establishing the inherited IRA.

An inherited IRA must be retitled to include the decedent’s name, the words “individual retirement account,” and the beneficiary’s name. The IRA cannot simply remain in the decedent’s name. The beneficiaries should also designate beneficiaries for their own IRAs. Please call if you’d like to discuss this topic in more detail.

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