Finance - 218 (3)

RE: Previous article on STRETCH IRA’s

From: William Kattula

Date: 10/7/2014 9:16:44 PM

To: misc@pilotcommunication.net

Subject: IRA/Roth IRA

        Regarding the IRA/Roth IRA article in latest PCN-I raised  the same question to both my Vanguard and Fidelity reps and got the same answer. We all have different wants, needs and circumstances and no one answer is good for all. What you are doing when you when you convert your IRA to a Roth IRA is prepaying the taxes for your beneficiaries. If you convert $500,000 you will be hit with at least a 25% tax bill on the amount-$125,000!!  So, if you want to continue to breast feed your children go ahead and convert and pay the taxes for them now especially when the market is at an all time high or let them pay the taxes as they should over their life span. About the Roth IRA continuing to “grow” tax free- there is a universal disclaimer “all investments involve risk  and you could lose money”-there are no guarantees-remember 2008-2009! If you just want to spend some of your hard earned cash, USAA will sell you a $500,000, 10 year term life insurance policy for about $430 per month for a healthy 70 year old. Proceeds are tax free.What you are buying is death insurance. Willie Kattula retired 2004

Editor:  Thanks Willie for the post.  I agree with you “no one answer is good for all.”  The Stretch IRA strategy is not right or even interesting to all but some may like it.  It doesn’t, however, have to involve a Roth conversion.  There are simple ways to stretch the IRA’s effectiveness for family wealth without conversion.  Thanks again. 

Helpful miscellaneous articles regarding our retirement plan and planning.  Like you, I review my retirement nestegg and plan from time to time.  Recently, I went though some continued education for some credentials I maintain and it occurred to me that we all could use a review about these issues.  So with your help, we will share and post articles and info that may be helpful and of interest to many of you in this section.

Here are a couple on setting up IRA beneficiary designations and then keeping them updated!

The Motley Fool

Managing Your Retirement

Designating IRA Beneficiaries

Most of us will roll our retirement plan money into a traditional IRA to continue tax deferral when we retire. But of course -- why pay extra income tax when we can delay the bill for many more years? Through years of cussing out the government whenever we look at our paychecks, we've all developed a pretty good set of instincts on not wanting to pay any more in taxes than we have to.

But while most of us are highly cognizant of how taxes affect us through our lifetimes, we tend to forget that any distribution from a traditional IRA is subject to income tax -- even an IRA that's left to our heirs. Thus, the beneficiary selection we make for that IRA has a significant impact on the overall income tax burden to our families. For that reason, your heirs will be eternally grateful to you if you learn the major rules regarding the distribution of traditional IRAs at death.

Spouses

Though it may be the case that really understanding your spouse is one of life's greater challenges, understanding the tax effects of making your spouse a beneficiary of a your traditional IRA is actually pretty simple. A widow may treat a departed spouse's IRA as her own. (The rules apply equally regardless of whether we're talking about widows or widowers here.) As a widow, she may roll her husband's IRA to her own IRA and continue the tax deferral. Easy enough.

Non-Spousal Beneficiaries

All other beneficiaries must take and be taxed on a distribution from an inherited traditional IRA. In essence, non-spousal beneficiaries have two choices on how to take distributions.

• The Lump Sum: No later than December 31 of the fifth year following the IRA owner's death, non-spousal beneficiaries may cash in the IRA without penalty, pay ordinary income taxes, and keep what's left. This distribution procedure is known as "the 5-year rule."
• Little by little: Non-spousal beneficiaries may have the IRA proceeds paid out over their own life expectancies and pay ordinary income taxes on the amount distributed each year. The election to have the IRA distributed over their lifetimes must be made and implemented no later than December 31 of the year following the year of the IRA owner's death. If the election is not made by that date (and, hey, that's more than a full year to decide), then all the proceeds must be withdrawn and taxed using the 5-year rule discussed above.

Things to Consider

Until 2001, the designation of a beneficiary for your IRA was extremely important. Why? Taxes, taxes, taxes. Because of large payouts from retirement plans, years of tax-deferred compounding, and successful use of a Foolish investment strategy, there is a lot of money currently stashed away in our collective IRAs. The ability to delay taxation of those proceeds means your heirs will keep more of what they deserve, and the sticky-fingered federal and state governments will just have to keep running lotteries to collect all that they want. Consequently, under old IRS rules, the selection of our beneficiaries was (and to some extent still is) an important decision that we neglected at our family's peril. And that issue is of particular importance when we must begin taking an annual minimum required distribution (MRD) from those IRAs.
Under the old distribution rules, IRA owners who reached age 70 1/2 had to select a beneficiary for those accounts. Then they had to decide whether to take withdrawals from IRAs using a joint or single life expectancy under a term-certain, recalculation, or hybrid method of withdrawal. All of those choices were irrevocable, and they determined how rapidly IRA balances had to be withdrawn by the owner during life or by the beneficiary after the owner's death. Up to eight different methods of calculating MRDs existed. And, choosing the wrong method and/or beneficiary could -- and, unfortunately, often did -- cost the family huge losses to the taxman.
Now, however, most of us can bid adieu and good riddance to those complex choices. The IRS has issued new IRA distribution rules. As of January 1, 2001, those who reach age 70 1/2 (or those who are have already started MRDs based on that age) have a choice of using the new rules or the old ones. "What," you ask, "do the new rules change?" Simply stated, they change a lot. First and foremost, they require the use of one uniform life-expectancy table. That table is based on the account owner's attained age, and it assumes the owner has a beneficiary who is 10 years younger than he or she is. Each year, the account owner finds a factor in that table based on his or her attained age in that year. That factor is then divided into the account balance as of the end of the previous year. The result becomes the MRD the person must take in the new year. The new method for calculating MRDs helps reduce the income taxes due currently, and prolongs both the tax-deferred compounding and the life of the IRAs for almost all families.
Under the new rules, selecting a beneficiary when your MRDs begin is no longer critical. You may now change beneficiaries at will, because choosing a beneficiary will have no impact on how fast your retirement account must be paid out during your lifetime or after you die. In fact, when you finally meet your maker, the actual beneficiary doesn't even have to be determined until December 31 of the following year. That little proviso allows a primary beneficiary (such as a spouse) to disclaim the account in favor of a younger, contingent beneficiary (such as a child or grandchild). The newly named beneficiary could then take MRDs from what's left in the retirement account over his or her life expectancy in that year. Result? A significantly delayed payment of income taxes on the amount in the IRA.
The old MRD rules forced an immediate payout of your IRA at your death whenever the beneficiary you had selected when MRD began was no longer living. That meant a $500,000 IRA, as an example, had to be paid out in one year to surviving children when a spouse, who was the original beneficiary, predeceased the IRA owner. It made no difference the IRA owner had named the children as the new IRA beneficiaries. Now children in a similar situation may elect to have the IRA paid out over their lifetimes, which significantly lessens the income tax impact on that IRA balance to those heirs.
In fact, the only way the life of the IRA can't be prolonged is by your failure to name an IRA beneficiary at all. In that event, and if you had not yet reached your required beginning date for MRDs, the account would have to be paid out to your estate by December 31 of the fifth year following the year of your death. If you die after MRDs have begun, then the account can be paid to your estate over time, based on your remaining life expectancy as calculated as of the year of your death. That life expectancy would be reduced by one in each subsequent year to calculate the subsequent year's payout.
All in all, the new IRA distribution regulations seem to offer superb planning opportunities for families when it comes to how surviving family members must take MRDs from those IRAs. Smile. The IRS just gave all of us a gift. Now let's be Foolish by ensuring we and our heirs understand what that gift means.

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Designating IRA Beneficiary Critical in Estate Planning

Properly designating your IRA beneficiary can be an important part of your estate plan. Otherwise, your heirs may have to pay more income and estate tax than necessary after you are gone.

You must customize your IRA beneficiary designation to fit your goals. The most common beneficiary designations are spouses, children, grandchildren or other loved ones. You also may name a trust, a charity, or a combination of individuals, trusts or charities. After your death, distributions from your IRA will be required, and who you’ve named as beneficiary can dramatically affect the income tax consequences. Let’s examine important considerations when completing your IRA beneficiary form.

It is Important to Name a Contingent Beneficiary

If you name an individual as the primary IRA beneficiary, you also should name a contingent beneficiary. Why? Because your primary beneficiary may predecease you. If your IRA does not have a designated beneficiary, most plans require your estate to be the default beneficiary. This usually produces unfavorable tax results.

IRA benefits payable to an estate must be distributed within five years of your death if you die before your required beginning date (RBD — April 1 following the calendar year in which you reach age 70 1/2) or during your remaining single-life expectancy if you die after your RBD. An individual, and certain trusts can enjoy more favorable tax treatment, however, because they generally are permitted to take required minimum distributions (RMDs) from an inherited IRA over the life expectancy of the individual or of the trust beneficiary.

In addition, in 2013, an estate reaches its highest income tax bracket (40%) once taxable income exceeds, $11,950, while an individual must have more than $400,000 ($225,000 if married filing separately) of taxable income before the 40% rate applies.

How to Name Multiple Individual Beneficiaries

If you name multiple individuals — such as your children — as your primary beneficiaries, they must use the oldest beneficiary’s life expectancy to determine the RMD from your IRA. This is often called the “oldest heartbeat rule.” An exception to this rule provides that, if the IRA is divided into a separate account for each beneficiary, each beneficiary may use his or her own life expectancy to measure the RMD. To do this, each separate account must be established by September 30, of the year following the year of your death.

You should also specify what happens to the share of a child who predeceases you. State law generally presumes that a bequest to a blood relative automatically passes to that relative’s descendants in such situations. That presumption, however, may not apply to an IRA beneficiary designation form. In fact, many IRA custodian agreements require that, in the case of multiple primary beneficiaries, the account be paid equally to those class members who survive you, unless you specify otherwise.

If you name your children equally as primary beneficiaries, you probably want a deceased child’s share to pass to his or her children (your grandchildren). This distribution method often includes the phrase “by right of representation” or the Latin phrase “per stirpes.” Thus, you may specify on your IRA beneficiary designation form, for example, “My children, Alan, Brian and Catherine, who survive me, in equal shares, except that a deceased child’s then-living children shall take in equal shares by right of representation the share that the deceased child would have received if living.” Or you could specify, “Equally to my children, Alan, Brian and Catherine, or a deceased child’s surviving issue, per stirpes.” Either designation will create the desired result.

How to Name your Living Trust as Beneficiary

An IRA participant with a living trust may consider naming it as the primary or contingent beneficiary. (If married, the participant may, for example, name his or her spouse as primary beneficiary and the living trust as the contingent beneficiary.)

When you name a living trust as either a primary or contingent designated beneficiary, ensure the trust agreement is drawn properly. If it isn’t, the entire account balance may have to be withdrawn within five years of your death. Additionally, if the trust provisions governing how trust assets are to be divided upon your death are not properly drawn, the designation of the living trust as a beneficiary of the IRA may accelerate the income tax on the IRA as income in respect of a decedent.

Frequently, a participant’s living trust divides into shares when the grantor dies. For example, say you have a living trust and the trust agreement provides that on your death the trust assets are allocated and divided equally among your three children. Is the separate account rule available to your three children as beneficiaries of the living trust? Must the RMD be paid over the life expectancy of the oldest child? Or, may each child use his or her own life expectancy?

The IRA minimum distribution rules say that the separate account rule does not apply. For the separate account rule to apply, the allocation and division of the IRA into separate shares for each of the three designated beneficiaries must occur in the IRA beneficiary designation form, rather than in the living trust agreement.

Therefore, if you want shares passing to your children to qualify as separate accounts, you must name them (or create separate trusts for them) directly as IRA beneficiaries, instead of naming your living trust as beneficiary.

Carefully Considering your Beneficiary Designation Helps Manage Tax Bite

When you designate your IRA beneficiary, pay careful attention to the tax and non-tax consequences. Because the rules are complicated and potential tax traps exist, please seek the advice of tax, legal, and accounting professionals before making any IRA beneficiary designation.

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(As with any of these informative articles, anyone who needs someone to talk to about

this very subject contact me and I can direct you to a knowledgeable advisor).

 



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