Don’t Throw Away Your Legacy! - Rodgers & Associates

Don’t Throw Away Your Legacy!


Desig­nating an IRA benefi­ciary is almost an after­thought for most IRA owners. Lack of attention to this seemingly simple procedure can create costly tax impli­ca­tions for benefi­ciaries.

The growth of IRA values over the next ten years will be staggering as baby boomers retire and rollover their company retirement plans. It is not uncommon to see seven figure IRAs due in large part to the rollover of pension distri­b­u­tions to self-managed IRA accounts. These larger accounts carry huge potential tax traps for the unwary.

The tax problems associated with IRA distri­b­u­tions have largely been overlooked as investors have concen­trated on filling the accounts. Now, as age catches up, investors will come face to face with the complex rules laid down by the IRS that can easily turn a golden nest egg into a rat’s nest of tax problems.

Here are a few tips for IRA distri­b­ution planning. To begin, it is helpful to under­stand taxation of IRA distri­b­u­tions. IRAs are subject to three taxes. First, every dollar taken out, regardless the circum­stances or who withdraws the money is taxable as ordinary income to the owner who makes the withdrawal. Second, money taken out before age 59 is subject to a 10% excise tax in the year withdrawn (unless it meets one of the eight excep­tions). Finally, IRAs owned by a decedent are subject to inclusion in the estate for purposes of computing death, or estate taxes.

Spouses who inherit IRA accounts from a recently deceased spouse who has not begun mandatory distri­b­u­tions have the option of rolling the IRA into their own IRA or leaving it in the name of their spouse. If the spouse is younger than 59½, once the IRA is rolled over into his/her account, the distri­b­u­tions are subject to the 10% excise tax rule if taken out before age 59½. A better plan, for the spouse who may want to use this money early, is to leave it in the name of the decedent and withdraw over time as the benefi­ciary, without tax penalty or restric­tions.

Non-spousal benefi­ciaries who inherit IRAs for an owner who has died before age 70½ have two choices for distri­b­ution. They may take distri­b­u­tions either within five years from the date of death of the owner or they may elect to take minimum distri­b­u­tions over their life expectancy. For larger accounts, signif­icant tax savings can result; and signif­i­cantly more wealth can be realized by having the distri­b­u­tions made over a younger beneficiary’s lifetime. This election must be made by December 31 of the year after the owner’s death.

There is little downside to electing the lifetime option because the benefi­ciary may take out more than the minimum at any time.

IRAs have a special attraction for tax planning because they provide an envelope inside which the invest­ments can grow tax deferred. This envelope can be collapsed, causing an unwanted distri­b­ution within a year of the owner’s death … and immediate taxation of the entire account balance if one of the following mistakes is made:

  • Name your estate as the benefi­ciary, and the estate, which has no life expectancy, will pay ordinary income taxes on the account balance within the year.
  • Failing to name a benefi­ciary on an IRA or pension account can cause the same, unwanted, but completely taxed, results.

IRA distri­b­ution rules are complex. Before you begin minimum distri­b­u­tions at age 70½, it will pay to seek profes­sional advice to avoid unwanted tax results.

Rick’s Insights

  • IRA distri­b­ution rules are complex. Seek competent advice to make sure minimums are met on a timely basis.
  • Many mistakes are made each year with distri­b­u­tions from inherited IRAs. Distri­b­u­tions can be spread over time to minimize income taxes if set up properly.
  • Failing to name a benefi­ciary on an IRA reduces the distri­b­ution options for your heirs. Always name a benefi­ciary.