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  Category: Articles » Finance » Article
 

IRA Distribution Mistakes--How to Blow your Retirement Money




By Larry Klein

With the population aging and over 4000 people a day
being forced to take IRA distributions (such distributions
are mandatory by April 1 after reaching age 70 1/2),
mistakes in taking IRA distributions can total in the billions.
Yet, because people have had no prior experience,
mistakes are rampant. Here are 4 common IRA
distribution mistakes to avoid.

IRA Distribution Mistake #1
Every IRA owner can name a beneficiary and "stretch" the
IRA for maximum tax deferral over the next generation.
Informed IRA owners believe that the following will occur
with retirement assets they do not use during their lifetime.
Say they leave $500,000 of retirement assets to heirs.
They believe junior will make small withdrawals each year
(required by IRS) and at 6%, the account with a 42-year-
old beneficiary, will generate $2.5 million during junior's
lifetime (IRA distributions plus ending balance at life
expectancy). This sounds great but it may never happen.
There are at least 2 ways that the stretch IRA can fail. The
first way is because of a custodian with rules that do not
permit lifetime IRA distribution payments. This is
particularly common in qualified plans where the rule may
be that "all IRA distributions to beneficiaries are to be
completed within 5 years." Since no one ever reads that
fine print for their qualified plan, they have no idea that a
fast IRA distribution will be forced to non-spouse
beneficiaries.

The other problem is the beneficiary. Just because mom
and dad have the good sense to understand tax deferral
does not mean that junior will comply with this wisdom.
The minute junior finds out that he can close the IRA,
distribute all the money and buy a Ferrari and Lamborghini
at the same time, he does so, pays a fortune in taxes and
blows the money to have fun.
The way to control this is to have leave retirement assets in
an IRA trust. In a trust, mom and dad can control how the
heir gets paid.

IRA Distribution Mistake #2
I am leaving my IRA to my wife. I only have one son and
he can do with the IRA what he wants when we are both
gone. My situation is simple.When most people select
beneficiaries for their IRAs, they select their spouse or their
children. As simple as this seems, it can create problems.
Consider these two scenarios.
When a plan owner leaves an IRA account to the spouse, it
inflates the spousal assets. And when the spouse later dies
with an estate exceeding $2 million (the estate exemptions
limit in 2006), they pay estate tax. By leaving the IRA to the
spouse, the deceased spouse has created unnecessary
estate taxes by making the survivor's estate larger.
So instead, they leave the IRA to the son. But as indicated
before, this leaves the son total control over the asset. He
may withdraw the funds immediately and decide to buy a
mansion jointly with his spouse (who was despised by
mom and dad). To complete the misery, let's say that the
following week, the daughter-in-law files for divorce and
gets to keep the mansion in the settlement. Mom and dad
just gave the despicable daughter-in-law a mansion with
their IRA money. Even in death they have money
problems.

To avoid the above two scenarios, they decide to leave the
IRA to their "estate." Many attorneys advise that you never
leave a retirement plan to your estate. Because at death,
the IRS requires the account to be rapidly distributed rather
than enjoy the potential stretch over the lifetimes of
beneficiaries. Additionally, the IRA will now be a probate
asset and subject to claims of creditors. So what do rich
people do to avoid the three gloomy scenarios above?
They leave their IRA in a trust and appoint a trustee like an
accountant, financial advisor, attorney, etc., a person that
has good common sense and tax knowledge. Within the
boundaries of mom's and dad's wishes and IRS-required
minimum distributions, the trustee will determine who
among the beneficiaries will get the IRA and how much
they get. The trustee will determine how quickly this IRA
money gets distributed over and above the annual
minimum amount of required IRS IRA distributions. Mom
and dad can even give very detailed instructions. For
example, they could dictate no IRA distributions for
purchases of homes with the despicable spouse. Or if the
money is to be used for education they may stipulate that
up to $15,000 a year can be distributed, or to start a
business up to $25,000 can be distributed, and they can go
on and on with such instructions.

IRA Distribution Mistake #3
The IRA owner has checked with the custodian and yes,
they do allow lifetime distributions to non-spouse
beneficiaries. Additionally, their two unmarried sons
understand tax deferral and there is no need for a trust.
Everything is okay.

Many plan owners don't consider what happens if their
beneficiary pre-deceases them.

Let's say you have two sons, Jack and Tom. Your name
them as primary beneficiaries for the IRA distributions by
completing an "IRA Beneficiary Designation Form" at the
bank or securities firm.
Jack and Tom each have a son. Jack's son is Bob. Tom's
son is Dan. So you write the grandson's names on the line
of the beneficiary designation form that says "secondary
beneficiaries."

If Jack dies before his parents who own the plan assets,
they probably think Jack's share goes to his son, Bob.
Wrong.

It goes to Tom, because on the beneficiary designation
form, there is no place to specify how the primary
beneficiaries and secondary beneficiaries are related.
There is no place for you to explain your intentions or write
"per stirpes" to clarify intentions with respect to those
beneficiaries. Those beneficiary designation forms with the
bank or the securities firm are not sufficiently detailed to
carry out your wishes.

At minimum, you should replace those forms with your
own forms, called an "IRA Asset Will." This can be
inexpensively prepared by any attorney. And if the
custodian won't accept it, move your account to another
custodian.

IRA Distribution Mistake #4
Failing to use IRA funds for charitable intent
If you want to leave even $1 to charity, do it from your IRA
money. You can specify one or more charities to receive
portions of the IRA and the heirs will thank you. When
taxpayers leave heirs a dollar of IRA funds, the heirs will
pay, for example, 35 cents to tax and have 65 cents left to
spend. If the estate is over $2 million, heirs will also pay
estate tax on this money and may have only 30 cents left
from each dollar. However, when mom and dad leave
heirs a dollar that is non-retirement money, heirs can
spend it with no income tax. Therefore, heirs would much
rather have "regular" money and not IRA money.

 
 
About the Author
Gain more knoweldge about managing your IRA from Larry Klein, CPA/PFS, CFP at Required Minimum Distribution and financial advisors can download an entire library of articles at IRA Distribution

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