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. In addition to retirement planning vehicles, IRAs are thus becoming estate-planning tools. 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, which includes individuals and 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.
- 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 oldest beneficiary’s life expectancy. 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 if the owner dies before required distributions begin or over the owner’s life expectancy if the owner dies after required distributions begin.
- 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. Spouses under age 59½ can take withdrawals from the original IRA without paying the 10% federal income tax penalty. Spouses who are older than the original owner can delay distributions by retaining the original IRA. Also, 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 first.
- 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.
Copyright © Integrated Concepts 2012. Some articles in this newsletter were prepared by Integrated Concepts, a separate, nonaffiliated business entity. This newsletter intends to offer factual and up-to-date information on the subjects discussed, but should not be regarded as a complete analysis of these subjects. The appropriate professional advisers should be consulted before implementing any options presented. No party assumes liability for any loss or damage resulting from errors or omissions or reliance on or use of this material.