Mistake 8: Improper funding of the Exemption Trust, Martial Trust, Q-Tip Trusts, or and other Trusts.

Posted on by in IRAs, Tax Law.

While the following point is much less likely to occur due to the portability of exemption amounts between spouses it is still important to know the possibilty exists.  It is also important to know just how easy this is to avoid by speaking with your advisor about your situation.

Let us assume that the beneficiary of the IRA was a revocable living trust (RLT) and that this trust states that upon the death of the first spouse, a new trust should be established and funded up to the current exemption equivalent. I have seen many cases where the attorney has “carved out” this exemption amount from the IRA in order to fund this exemption trust, and then suggested rolling over the difference into the surviving spouse’s IRA. Although this can be done, it has to be done properly!

I have seen countless examples where the exemption was in fact carved out and paid out directly into the exemption trust! One hundred percent of this money was subject to income taxation in one year, and if that isn’t bad enough, it was all taxed at the trust income tax rate brackets, which are usually much higher than individual income tax rates!

What should be done is to establish an Inherited IRA for the benefit of the exemption trust.  Please remember that many attorneys and accountants have not heard of an Inherited IRA and believe that the exemption trust beneficiary would have to receive the money in order to have it funded. Please make sure that your financial advisor is aware of these complicated rules.

Again, this is an easy mistake to avoid based on new portabilty laws, but a situation involving funding of trusts for minors can come up.  Remember that when people set up trusts for minors it is important the trust contains both the proper language to qualify for the stretch IRA and that the financial advisor properly titles the inherited IRA for the benefit of the trust established for the minor.

Information provided by MD Producer

Mistake 7: Not establishing the Inherited IRA properly.

Posted on by in Estate Planning, IRAs, Tax Law, The Lange Money Hour.

There are a number of rules that must be met in order to properly establish an Inherited IRA:

  1. Notification must be made to the custodian in writing.
  2. The first minimum distribution must be taken no later than December 31st of the year following the year the person passes away. Note: if the decedent was receiving lifetime RMDs, the beneficiaries must ensure the RMD has been taken for the year of death.
  3. The IRA must be retitled properly showing the following information (something that Jim has covered on the radio show more than once, due to the number of times mistakes are made on this key point):
    1. The decedent’s name, with “deceased” or “decedent” after the name.
    2. It must show that it is still an IRA.
  4. Retitling must be done by December 31st  after the year of death.

If these requirements are not met, then most beneficiaries will be faced with the following consequences:

  1. If the orginal account owner was RMD age or older, the IRA must be distributed over the owner’s remaining life expectancy, based on the single life table.
  2. If the orginal owner was under RMD age, the entire IRA account must be distributed no later than December 31st of the fifth year after the person passed away.
  3. If the account title is not worded properly the entire account could also be subject to immediate taxation all in one year!

Make sure you discuss all the vaious laws and titling issues with your advisor when establishing an inherited IRA.

Information adapted from MD Producer material

 

Mistake 6: Taking the money from the IRA, rather than properly establishing an Inherited IRA.

Posted on by in IRAs, Tax Law.

This is one of the most common mistakes for the following reasons:

  1. The client is not aware of the retirement distribution rules and merely asks for a total distribution of the IRA.
  2. The client asks the custodian/advisor what to do and is merely asked to sign a form so a check can be sent to them.
  3. The client’s CPA and/or lawyers are not familiar with this area of the tax law.
  4. The beneficiary is made aware of these new rules by the advisor and the beneficiary still says, “I need the money now. Give me the check!”

The last one is an example that I also encounter frequently. For example, a young man might come to me who is the beneficiary of his deceased father’s IRA. The IRA is worth $1 million. I look at the life expectancy table and explain to the son that if he makes the proper election, he will only be required to take out about $30,000 from the IRA and he could leave the other $970,000 tax deferred (I’ve also reviewed the entire estate and allocated for estate taxes).

In many cases, the child will respond, “Thank you for all that wonderful information. However, I would just as soon spend the money now! Close out my dad’s IRA and transfer all the money into my bank account.”

Unfortunately, this often happens in the real world and is a perfect example of improper planning! One of the key issues that an advisor should discuss with his client before he or she passes away is the possibility of establishing an Inherited IRA Trust, also known as an IRA Legacy Trust, Stretch IRA Trust, etc. This document specifically states what steps and elections the beneficiaries must take after the client passes away.

Ask your advisor about establishing an Inherited IRA Trust, which names a separate trustee to make decisions on behalf of the beneficiary.  While it is not a perfect solution in every scenario, there are a lot of benefits in the right set of circumstances.

Not all custodians allow for this type of planning, and of course, not all situations warrant this type of planning.  However, knowing your options can only help you when it is time to talk to your advisor.

Adapted from MD Producer materials

Mistake 5: Rolling over an IRA when this is not allowed.

Posted on by in IRAs, Tax Law.

As I mentioned earlier, only a spouse may roll over an IRA into his or her name. This can happen in a variety of circumstances:

  1. The spouse is the primary beneficiary.
  2. The spouse is the contingent beneficiary and the primary beneficiaries disclaim their part.
  3. The beneficiary of the IRA is a trust/estate, and the spouse is the sole beneficiary of the trust/estate and all  other conditions are met.

However, I have seen many cases where the beneficiary other than the spouse, such as the son or daughter, has taken the money and rolled it over into his or her own IRA! This is not allowed! Please remember that not only will the non-spouse beneficiary have to pay income taxes on this distribution all at once, but there is also a penalty for rolling over too much!

As mentioned above, the proper course of action would be for the non-spouse beneficiary to establish an Inherited IRA and at least allow the tax to be deferred over a long period of time, rather than paying the tax all at once.

As discussed earlier, non-spouse beneficiaries are allowed to directly transfer (i.e., a direct rollover) an inherited qualified plan to an inherited IRA as long as such a transfer is allowed under the plan document. It is important for your advisor to review your plan document to determine if such a rollover is allowed.

When such a transfer is made, the payout period that the beneficiary must follow under the IRA will depend on a number of factors.

If you are a non-spousal beneficiary of a qualified plan, it is highly recommended that you consult with an advisor who is familiar with the rules before you make a rollover to an Inherited IRA.

Adapted from MD Producer Materials

Mistake 4: Immediately rolling over the money from the decedent’s IRA over to the spouse’s IRA.

Posted on by in Beneficiary Designations, Estate Planning, IRAs, Tax Law.

This is not usually a good idea until the entire finances of the deceased and the beneficiaries are reviewed in detail. I always recommend contacting the client’s CPA and estate attorney in order to determine whether or not there are going to be any estate tax issues. For example, it is possible that the surviving spouse would actually want to disclaim some or all of the IRA in order to reduce any unnecessary estate taxes.

In addition to this, if you roll over your spouse’s money into your name and you are under age 59 ½, you may have to pay a penalty if you need to take a distribution before you turn 59 ½. This is called the “Spousal Rollover Trap.”

One of the options you could take in these circumstances is to utilize section 72(t) of the Internal Revenue code and take out the money before age 59 ½ without paying a penalty by using “substantially equal payments.” However, if you are many years away from this date and if you leave money in the decedent’s IRA, then you can take out money from the decedent’s IRA without any restrictions at all!

As you can see, a surviving spouse must be careful to investigate all options before rolling over the decedent’s IRA into their own name.

 

Adapted from MD Producer Materials

Mistake 3: Having too many IRA custodians.

Posted on by in Estate Planning, IRAs, Tax Law.

You should try to limit the number of custodians because each IRA custodian is different and in order for you to remain current on the new rules and regulations, you must remember that each of the IRA custodians may or may not be current on all the tax laws. The more custodians that you have, the more work you will have to do in order to determine whether or not they are up-to-date.

Imagine if you have 10 IRA custodians, you would have to review 10 different custodial accounts and keep current on each of these changes as the IRA custodians make them!

Many IRA custodians may not allow you to implement your desired plan. If they are not flexible, then it is time to switch. Many beneficiaries are not aware that they do not necessarily have to put up with the prior owner’s custodian. The IRA can usually be transferred from one custodian to another IRA custodian without any tax consequences.

 

Adapted from MD Producer

Mistake 2: Not keeping up with all of the current tax law changes.

Posted on by in IRAs, Tax Law.

This is a major issue, since many new tax laws may come into effect and, as mentioned earlier, the IRA custodian may not be familiar with or have even implemented these new rules.

With the ever-changing nature of the tax laws, it is vital that you meet with an experienced financial advisor so you know what is and what is not allowed and the proper way to handle your retirement plan distributions.

 

Adapted from MD Producer

Mistake 1: Not seeing a qualified tax or financial advisor before making your decision

Posted on by in Estate Planning, IRAs, Tax Law.

Unfortunately, many beneficiaries do not seek a qualified tax or financial advisor and make retirement account decisions on their own or through the use of an unqualified individual or company.

There are a number of different rules that must be followed in order to prevent the IRS from being a primary beneficiary of your retirement account.

Your financial advisor should be competent in all of the different areas of financial planning, especially estate planning, income tax planning and retirement distributions. Please also remember that they should determine whether or not there is any estate tax due on the IRA account. Unfortunately, many people confuse “probate” with estate taxes. Retirement distributions will usually avoid probate, but are always subject to estate taxes. Therefore, please make sure that your advisor reviews this issue as well.

Many advisors may have heard of the Inherited IRA; however, many financial advisors have never established one before! Please ask your advisor/custodian how many Inherited IRAs they have established in the past because if this is the first time they have established one, we all know what happens the first time we do anything! It is called the learning curve. Many of the mistakes that I see are because the financial advisor is not familiar with all of the details and, unfortunately, the client is the “guinea pig.”

Remember the old expression, “We have theory, and then we have the real world.” Please make sure that your advisor understands the “real world.”

Be careful in choosing a custodian. It is often very difficult for custodians to keep up on all the new tax law changes and apply these to their custodial accounts because this is not usually a major priority since the profits on IRA account fees for many custodians is minimal or non-existent.

Your tax or financial advisor should also review your total financial picture before any decision is made because this inheritance can affect your current financial affairs. The financial advisor should review the impact of this inheritance in the following areas:

  1. Income taxes.
  2. Estate plan. You might not have had a large estate and now you do! You might need to have your will or trust updated due to this inheritance.
  3. Estate taxes.
  4. Investments. Your risk tolerance level could be significantly different from that of the individual who just passed away. Please check each of your investments to determine whether or not they are still appropriate.  In most cases you will be able to reposition these assets within the IRA without any income tax consequence.
  5. Cash flow needs. It is very possible that you do not need the entire IRA balance all at once.

Talking through these points with your advisor will help you avoid some of the most common mistakes of inherited IRAs.

 

Material Adapted from MD Producer

Blog Series: The Top 10 Mistakes People Make When They Inherit an IRA – and How to Avoid Them!

Posted on by in IRAs, Tax Law.

Retirement accounts make up the majority of many people’s estates and, unfortunately, many owners of IRAs are not aware of all of the complicated tax laws regarding distributions from these retirement accounts.

Although many individuals have established complex estate planning strategies, such as revocable living trusts, irrevocable life insurance trusts, etc., many individuals have not addressed the complex estate planning issues of inheriting an IRA.

Many people are faced with very important decisions when they inherit an IRA. To top it all off, if their decision is not the best choice, it is usually irrevocable!

Unfortunately, IRA accounts are subject to many different types of taxes and penalties upon death, which is often referred to as the “triple tax syndrome.”

Improper decisions can be financially devastating. Therefore, it is extremely important that you seek qualified, competent financial counseling before you make your final decision with regard to what action you will take.w

Over the next 10 days we will outline 10 mistakes to avoid when dealing with inherited IRAs and important issues associated with them for you to discuss with your trusted advisors.

 

Subject matter adapted from MD Producer material.

 

Answers to The 70 1/2 Quiz!

Posted on by in 401(k), Estate Planning, Income Tax, IRAs, Tax Law.

Yesterday we tested your knowledge of the tax laws surrounding Required Minimum Distributions…  Let’s see how you did! 

  • 1 D: April 1, after the year that you turn 70 1/2. For example, if you turn 70 1/2. in the year 2005, the required beginning date would be April 1, 2006.
  • 2 Usually not.Let me explain. The year that you turn age 70 ? is often referred to as your required beginning year. You must take out a distribution for this year, but the government says that you have until April 1 of the following year before you need to actually take the money out.. Taking your beginning year distribution in the following year does not relieve you of the obligation to take a required distribution in that year, however. Thus, by waiting you will have to take two distributions in the following year-a delayed distribution from the beginning year and another for the current year!Why is this bad? Let us assume that your minimum distribution for the year 2005 was $15,000 and that you wait until March 31, 2006 to actually take out this amount. The $15,000 is treated as a distribution for the 2006 tax year.However, you also must take a minimum distribution for the year 2006, for which the deadline is December 31, 2006. If we assume that your minimum distribution for the year 2006 is $18,000, then your total distribution would be $33,000 in one calendar year! This might push you up into a higher tax bracket for 2006. Thus, in most cases it is best to take your minimum distribution during the year that you turn age 70 ?, rather than waiting until April 1 of the following year. It is best to prepare a tax projection in order to determine which way is best for you, depending on your circumstances.
  • 3 C: A 50% penalty. For example, if your minimum distribution was $20,000 and you only took out $8,000, then the difference would be $12,000. The penalty would be 50% of $12,000, which equals $6,000! Talk about a penalty!
  • 4 E: You can name almost anything or anyone. For example, you can name your spouse, children, grandchildren, a trust, a charity, your estate, or even your dog!
  • 5 A: YES! Under prior law, if you designated a charity as a partial beneficiary, this would prohibit your spouse from rolling over the rest of the proceeds or any of the other beneficiaries from electing to take IRA distributions over their lifetime. However, under the new laws, the spouse would have the right to roll it over into her IRA even though the charity was one of the primary beneficiaries, as long as the charity took out its distributions.
  • 6 No.?The final regulations no longer take the beneficiary into consideration.! It makes no difference even if there is no beneficiary because the individual would still take out a minimum distribution based upon the new table. There is an exception, of course, if a spouse is the primary beneficiary and he or she is more than 10 years younger than the IRA owner. In such a case you can use a different table that has longer life expectancies. However, in this example, this is not an issue.
  • 7 Yes!?If the spouse is the primary beneficiary of the living trust and the trust is the primary beneficiary of the IRA, and the other conditions listed below are also satisfied, then the IRS allows you to “look through” the trust and treat the spouse as being the primary beneficiary of the IRA. The spouse then has the right to roll it over into his or her own IRA.The required conditions are as follows:?
    1. The beneficiary designation must be valid under applicable state law.
    2. It must be irrevocable or become irrevocable at your death. Revocable trusts become irrevocable when you pass away and therefore a revocable trust can now be the beneficiary.
    3. All beneficiaries of the trust must be individuals.
    4. The beneficiaries must be identifiable from the trust document.
    5. A copy of the trust or trust certification that identifies the beneficiaries in any subsequent revisions must be given to the plan administrator no later than December 31st of the year after the?person passes away.
  • 8 D:The child would have the right to use any of these options; however, the best choice in most cases would be to take the distributions over his or her lifetime. The election must be made no later than December 31 of the year following the year of death. This is usually by far the best option for most non-spouse beneficiaries because it permits the maximum deferral for taxpayers who do not really need the money, while providing an option to receive the full amount in one year or over a five-year period if desired…Unfortunately, many IRA custodians default to taking out the distribution over a shorter period of time unless an election is made to extend it. Many beneficiaries (and their advisors!) are not aware of this rule and forget to make any election, and therefore are subject to the default provisions that the IRA custodian has. It is extremely important to review your custodian’s language in order to determine what options that they allow after you die.
  • 9 E: It doesn’t matter anymore! There used to be a number of factors to take into consideration before making your choice on calculating your Required Minimum Distribution such as selecting life expectancy, the recalculation method, single vs. joint, hybrid, term certain, etc. There is now one uniform table that most people will use. This table generally assumes that the beneficiary is 10 years younger than the IRA owner. The only exception is a situation in which the beneficiary is a surviving spouse who is more than 10 years younger than the IRA owner. Under the facts of this question, the spouse is 67 years old. Although this is only three years younger than the IRA owner, you can still calculate your minimum distribution assuming he or she is 10 years younger.
  • 10 C:?You might be depleting your IRA principal, but the IRS does not require this. The IRS merely requires that you take out a minimum distribution based on the new table and whether IRA principal decreases in a given year depends on whether the required distribution exceeds the growth in asset value for that year.For example, let us assume that your spouse is your primary beneficiary and both of you are 70 years old. According to the IRS tables, you have a life expectancy of 26.2 years. Therefore, if you have $100,000 in your IRA at the end of the prior year, you would have to take a minimum distribution of $3,817, which is about 4% of the IRA balance. If your investments inside of your IRA earn more than 4% , then your IRA will actually grow! The following chart illustrates what happens to your IRA balance if IRA investments earned a 10% return.

    IRA beginning balance:?$100,000

    Earnings during year:?10,000

    Less required minimum distribution -3,817

    Ending IRA Balance?$106,183

    Obviously, if your minimum distribution is greater than the earnings on your IRA, however, then you will start depleting your principal.