Transfer of wealth can be tricky
National Retirement Security Week came and went last week without making much of a peep. The objective was to raise awareness of retirement issues and call attention to financial education and preparation. Organizers pointed out that polls show 61 percent of Americans to be concerned about their ability to meet their financial needs in retirement. This implies, however, that 39 percent are convinced that they will have enough to retire and that they will not run out of money.
Fortune ran a story 20 years ago about the massive transfer of wealth taking place as the Great Generation was dying and passing assets on to their baby boomers — my generation. I recall that the number was well into the billions of dollars.
Today, the stage is set for another massive transfer as my generation starts to unravel and today’s personal wealth is transferred to yet another generation. The oldest baby boomers are within 10 years of their average life expectancy, and thanks to 401(k) plans, these folks undoubtedly constitute much of the 39 percent who are reasonably content with their financial circumstances.
What this also means is that another massive transfer of wealth is in the cards, because the total amount in retirement plans is now more than $30 trillion.
In my experience, most retirees manage to live largely on the earnings generated by their individual retirement accounts, which, in addition to providing income, also grow to keep pace with inflation. This means that the principal, largely intact, will be inherited by heirs, non-related beneficiaries and charities.
Setting the stage for an orderly and cost-effective transfer of an IRA upon death would seem pretty straightforward on the surface, but it can be one of the most complicated decisions related to the management and disposition of retirement assets.
Done correctly, it can generate a stream of income over many years that may be less than the account itself earns, so those excess earnings just cause the capital to increase in value.
Done wrong, the heirs can be forced to distribute the money no later than five years after death, and the entire amount becomes taxed as regular income to the recipients.
Even the different options for surviving spouses involve choices with consequences. For example, a spouse can receive all the money in an IRA tax free, but the question is whether to leave the account in the name of the deceased or roll it into a new IRA in the spouse’s name. In the latter case, the surviving spouse can then name his or her own beneficiaries rather than be limited to the contingent beneficiaries named in the deceased’s IRA account.
Leaving the IRA in the deceased’s name allows the spouse to take distributions before age 59 ½ with no 10 percent penalty. Rolling the account into the spouse’s own IRA triggers the 10 percent penalty for early distributions.
A non-spouse beneficiary who elects to change the name on the account from that of the deceased triggers an immediate taxable distribution of the entire IRA account.
A so-called “designated
beneficiary” is important because this allows the beneficiary to use life-expectancy calculations to dribble the money out over many years while allowing the principal to continue to grow. The IRA custodian will provide a form to designate the beneficiary. But, while the law may say one thing, the custodian’s plan may be more limiting. It’s the plan language that rules.
The resource that explains these issues in numbing detail is Twila Slesnick and John Suttle’s “IRA’s 401(k)’s and Other Retirement Plans — Taking Your Money Out.” Another respected resource is Ed Slott, whose collection of books covers various aspects of IRA management.