Don’t Throw Away Your Legacy!

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Inheritance 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 Second, money taken out before age 59 is subject to a 10% excise tax in the year withdrawn (unless it meets one of the eight exceptions).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.

Will Your Money Last Through Retirement?

No one wants to run out of money. But without goals and a solid plan,
how can you know for sure whether you’re on the right track?

Will I be able to maintain my current lifestyle?

What will my monthly income be in retirement?

Can I protect my hard-earned savings and still
have the income I want?

Rodgers & Associates answers questions like these every day.

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2025 Lititz Pike, Lancaster, PA 17601
Phone: 717-560-3800, Toll-Free: 888-876-3437