Win­ning the IRA Lot­tery

Help clients who in­herit money. Oth­er­wise, a few small, early mis­takes can cause them to lose out in a big way.

Financial Planning - - Contents - BY ED SLOTT

Help clients who in­herit money. Oth­er­wise, a few small, early mis­takes can cause them to lose out in a big way.

It’s im­por­tant to have a con­tin­gent ben­e­fi­ciary named in case a ben­e­fi­ciary dies be­fore the IRA owner and the form wasn’t up­dated.

A cou­ple of months ago, three peo­ple in New York, Iowa and South Carolina won hun­dreds of mil­lions of dol­lars in the Mega Mil­lions and Power­ball lotteries. If this lucky group in­cludes one of your clients, you don’t need to read this for them. The rest of you, pay at­ten­tion.

While the odds of win­ning these prizes are ex­traor­di­nar­ily low, there are many smaller but more likely jack­pots you can help your clients plan for and pro­tect, such as when they in­herit an IRA or Roth IRA.

In par­tic­u­lar, I’m re­fer­ring to IRAS chil­dren in­herit af­ter both par­ents have died, rather than those they may in­herit from a spouse.

Here are some ways you can help them pro­tect that IRA now and keep it grow­ing.

Proac­tive Life­time Mea­sures

First things first: Check the ben­e­fi­ciary form. Ad­vi­sors can help make sure the right ben­e­fi­ciary is named. It’s also im­por­tant to have a con­tin­gent ben­e­fi­ciary named to al­low more post-death flex­i­bil­ity or if the ben­e­fi­ciary pre-de­ceases the IRA owner and the ben­e­fi­ciary form was not up­dated.

Nam­ing an in­di­vid­ual on the IRA ben­e­fi­ciary form can al­low the ben­e­fi­ciary to ex­tend re­quired min­i­mum dis­tri­bu­tions over his or her life­time, known as the stretch IRA. This can keep that in­her­ited IRA grow­ing for decades.

How­ever, the stretch IRA does not pro­tect those funds from be­ing squan­dered. It only al­lows the ben­e­fi­ciary to ex­tend RMDS over the long­est pos­si­ble time frame.

The ben­e­fi­ciary can al­ways with­draw more and empty the ac­count when they wish, just like many lot­tery win­ners.

If the IRA is large, or the ben­e­fi­cia­ries isn’t equipped to han­dle a large in­her­i­tance whether due to age, in­ca­pac­ity, law­suits or a his­tory of fi­nan­cial prob­lems, your client may wish to name a trust as the IRA ben­e­fi­ciary. The trust can be used to make sure that large dis­tri­bu­tions are not with­drawn un­wisely. It should be flex­i­ble enough, though, to al­low the ben­e­fi­ciary to with­draw funds in ad­di­tion to the an­nual RMDS, for items like health, ed­u­ca­tion or fi­nan­cial emer­gen­cies. A re­li­able and com­pe­tent trus­tee should be named to make your sure your client’s wishes are fol­lowed and that

the IRA is pro­tected over the life­time of the ben­e­fi­ciary.

The U.S. Supreme Court has ruled that in­her­ited IRAS are not cred­i­tor pro­tected in bank­ruptcy (Clark v. Rameker, 2014). Let your clients know this in case they are wor­ried about their ben­e­fi­cia­ries be­ing vul­ner­a­ble to fi­nan­cial woes.

Like lot­tery win­nings, this in­her­i­tance may likely be a one-time event and the funds need to be sim­i­larly pro­tected. Nam­ing a trust in this case will pro­vide more pro­tec­tion than hav­ing a ben­e­fi­ciary in­herit di­rectly.

Many in­her­ited IRAS are lost im­me­di­ately af­ter death, mainly to un­in­tended tax­a­tion. Here are five rules to fol­low to avoid this.

Touch noth­ing: Ad­vice is crit­i­cal at this first stage. The biggest mis­takes hap­pen here. Some­times in­her­i­tors can’t wait to get some of that money and they ac­cess the funds too quickly, ex­pos­ing the en­tire IRA to im­me­di­ate tax­a­tion.

Ad­vi­sors need to ed­u­cate clients and in­form ben­e­fi­cia­ries that with­draw­ing in­her­ited IRA funds can­not be un­done. Once in­her­ited IRA funds are with­drawn by a non-spouse ben­e­fi­ciary (a child, grand­child, friend or any­one other than a spouse) those funds are sub­ject to tax­a­tion and they can­not be rolled over. A non-spouse ben­e­fi­ciary can­not do a rollover so the mis­take can­not be un­done.

We had a ben­e­fi­ciary years ago who with­drew around $600,000 from his fa­ther’s IRA be­fore an in­her­ited IRA was set up, and im­me­di­ately lost more than $200,000 to taxes.

Set up the in­her­ited IRA cor­rectly: What should be done first? Ad­vi­sors should know that af­ter death, no funds should be moved from the dece­dent’s IRA un­til a prop­erly-ti­tled in­her­ited IRA is set up.

The IRA should be ti­tled as an in­her­ited IRA. Be­fore any funds are moved, the ac­count should be re-ti­tled keep­ing the name of the de­ceased IRA owner on the ac­count and adding the ben­e­fi­ciary’s name to the ti­tle.

An ex­am­ple of a prop­erly-ti­tled in­her­ited IRA is: “John Smith IRA, de­ceased 11-5-18, f/b/o John Smith, Jr., ben­e­fi­ciary.”

Cor­rect ti­tling must also be done when a trust is the IRA ben­e­fi­ciary. In that case the ac­count can be ti­tled as: “John Smith IRA, de­ceased 11-5-18, f/b/o Adam Tay­lor, Trus­tee of The John Smith Trust, ben­e­fi­ciary.”

If there are mul­ti­ple ben­e­fi­cia­ries, then each ben­e­fi­ciary’s share must be set up as a sep­a­rate in­her­ited IRA. The split must be done as a di­rect trans­fer, and the split must be done by the end of the year af­ter death to al­low each ben­e­fi­ciary to do a stretch IRA based on their own life ex­pectancy.

No con­tri­bu­tions: Let IRA ben­e­fi­cia­ries know that this is an in­her­ited IRA, not their own IRA. They can­not make con­tri­bu­tions to this ac­count. If they do, they are deemed to have treated the ac­count as their own and the en­tire ac­count bal­ance be­comes sub­ject to tax­a­tion and must be emp­tied. An in­her­ited Roth IRA may not be tax­able, but the in­her­ited Roth IRA is also deemed with­drawn and the funds are no longer in­her­ited Roth funds, if con­tri­bu­tions are made to the ac­count.

Move in­her­ited funds cor­rectly: In­her­ited IRA funds can only be moved as di­rect trans­fers. As men­tioned ear­lier, a non-spouse ben­e­fi­ciary can never do a rollover. A com­mon mis­take oc­curs when an un­in­formed ben­e­fi­ciary wishes to move the funds to a dif­fer­ent bank, bro­ker or fi­nan­cial ad­vi­sor, or to you. If the funds are with­drawn as op­posed to a di­rect trans­fer, they be­come sub­ject to tax­a­tion and can­not be rolled over. This is another mis­take that can­not be cor­rected.

Take cor­rect RMDS: The 50% penalty for not tak­ing RMDS also ap­plies to in­her­ited IRAS. Help IRA ben­e­fi­cia­ries cal­cu­late the cor­rect RMD. If they are a des­ig­nated ben­e­fi­ciary, mean­ing the ben­e­fi­ciary is an in­di­vid­ual or a qual­i­fy­ing trust, they can use the stretch IRA. Use the IRS Sin­gle Life Ta­ble. Use the age of the ben­e­fi­ciary in the year af­ter death when RMDS will be­gin.

In ad­di­tion, if the dece­dent died be­fore tak­ing any year-of-death RMD, the ben­e­fi­ciary must take that RMD. If it is missed, it is the ben­e­fi­ciary who will be hit with the 50% penalty.

If the in­her­ited IRA is a Roth IRA it is sub­ject to RMDS, even though Roth IRAS are ex­empt from life­time RMDS. The ben­e­fi­ciary must take RMDS the same as for an in­her­ited tra­di­tional IRA. The RMD from the in­her­ited Roth will gen­er­ally be tax free but it still must be taken. If it is not, it will be sub­ject to the 50% penalty even if the RMD would have been tax free.

If you have a client who will be leav­ing an IRA to the next gen­er­a­tion, or your client has just won the IRA lot­tery by in­her­it­ing a sig­nif­i­cant IRA, use these proac­tive steps to pro­tect those funds and make them last. This is a valu­able ser­vice that is of­ten ne­glected. Help your new ben­e­fi­ciary clients keep their IRA pro­ceeds.

The odds of win­ning an ac­tual lot­tery are very low. But smaller wind­falls, such as in­her­ited IRAS, need prepa­ra­tion too.

Newspapers in English

Newspapers from USA

© PressReader. All rights reserved.