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Be Alert For IRA Troubles
read a fascinating article in the April, 1999 issue of Bloomberg Personal Finance, entitled "Heir of Dismay". Author Lynn Brenner opines that tax troubles may await many who own or inherit retirement account money, now totaling more than $1.4 trillion. This article will focus upon mistakes with IRAs that you inherit.
Brenner's four alerts are refreshingly easy to read yet full of good advice. The first alert regards an error frequently made. That is, beneficiaries of an inherited IRA do not realize (and are not advised) that they have inherited a large income tax deduction. In other words, the "estate tax deduction" allows you to use the federal estate tax levied on the IRA to reduce your income tax liability on the account.
The second warning with inherited IRAs is putting the IRA in your name without considering the consequences. There are several pitfalls, even when you inherit the IRA from your spouse, but the most noteworthy concerns the IRA inherited from someone other than your spouse. Quite simply, you cannot rollover. Brenner points out that most custodians (banks, brokerage firms, mutual fund companies) routinely rollover the deceased parent's IRAs into the child's name. This, she says is a "financial body blow", because the rollover immediately makes the entire rollover amount a taxable distribution.
To avoid that financial nightmare, set up one account in the name of the decedent for the benefit of each child. So, for son Mark of the decedent John Smith, who died on January 1, 1999, you should title the account, "John Smith IRA (deceased, 1/1/99), for the benefit of (FBO) Mark Smith".
The third alert relates to defaulting to the wrong IRA distribution method. If you inherit an IRA from someone not your spouse, and that person died before April 1 of the year after turning 70 1/2, you have a choice. You can choose to empty the account in 5 years, or over your own life expectancy. Assuming that your life expectancy is longer, choose your life expectancy. But remember to make that choice with your IRA custodian no later than December 31 of the year after the death. Otherwise, the 5-year rule applies by default.
Finally, nonspouse beneficiaries often make the mistake of emptying an account sooner than they have to do so. Most advisors know that there is a 10-year rule, which requires one determining joint life expectancy to assume that there only is a 10-year difference between the IRA owner and the nonspouse beneficiary. However, few advisors know that the 10-year rule does not apply when the IRA owner is deceased.
Here is the example provided. Dad is 70 and names his 40-year-old daughter as beneficiary. This means that their true joint life expectancy is 42 years. While Dad is alive he must use the 10-year rule. Thus, they have a 26.2-year joint life expectancy. If Dad dies at 80, the daughter can revert to their actual 42-year life expectancy at the time when she was named beneficiary, subtracting the 10 years that have elapsed since then. Thus, she is able to take distributions over 32 years.
We expect to see significant arbitration and litigation in the years ahead as advisors make mistakes regarding these kinds of financial planning concepts. Next time, we will examine the four mistakes commonly made with IRAs you own.
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Sponsored by James J. Eccleston, an attorney representing stockbrokers, financial planners and
investors nationwide in arbitration, litigation and regulatory matters, and a shareholder with the law firm
Shaheen, Novoselsky, Staat, Filipowski & Eccleston
P.C.(www.snsfe-law.com). This Web site contains material
of general interest. It is neither intended to, nor constitutes, either legal advice or investment advice.
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