We have seen many cases where the IRA is held in the form of an annuity product, with the insurance company as the custodian. I have read many contracts that  impose costs or other expenses to split the account into Inherited IRAs for multiple beneficiaries. Please review your contract carefully to make sure there is no penalty before you make this election.

In the event you find out that there is a potential penalty, at least there is usually a solution:

1. Retitle the account as an Inherited IRA with multiple beneficiaries, but keep it as only one IRA.
2. Open up a self-directed IRA at a brokerage firm with the same title.
3. Transfer the Inherited IRA from the insurance company in kind via a trustee-to-trustee transfer over to the new self-directed Inherited IRA account.
4. Liquidate the annuity product that is held by the self-directed Inherited IRA account (there should be no penalty or income taxes because the annuitant passed away and it is being paid out all at once and into another IRA).
5. Once the proceeds come into this new self-directed Inherited IRA, then split it into the various Inherited IRAs for each of the beneficiaries.

Sounds like a lot of work? It is, and that is the reason why you need an advisor you can trust to guide you through the process and you will most likely want to review all of your IRAs at this time in order to avoid having all these problems in the future.

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

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

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

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