Avoid Common IRA Inheritance Problems

Physician's Money Digest, October15 2003, Volume 10, Issue 19

Wall Street Journal

According to an article in the, complexlaws governing theways you're allowed to takedistributions and pay taxes make inheritingan IRA a complicated procedure.In addition, because IRAs are still acomparatively new financial product,those who inherit IRAs frequently donot know how to handle them.

Beneficiary Mistakes

Financial experts have identified themost common mistakes people makewhen they inherit IRAs. One blunderoften made by individuals who intendto leave an IRA to their spouse or childrenis losing the paperwork. Worseyet, the deceased may have neglecteddesignating a beneficiary or updatingthe IRA to reflect a new beneficiary.

Ed Slott, an accountant in RockvilleCentre, NY, recommends keeping aninventory. This inventory should includethe location of your designated-beneficiaryforms, the date you createdthem, the type of retirement account,the name of the financial institution,important phone numbers and accountnumbers, and the names of your primaryand secondary beneficiaries. Informbeneficiaries of the list's location.

Many physician-investors mistakenlythink they can roll an inherited IRA(also called a stretch, legacy, super,multigenerational, dynasty, or 100-yearIRA) into their own account. The onlyheir who can do this is the widow orwidower. All other heirs, including childrenand grandchildren, have to set upan inherited IRA. Rolling the moneyinto your own IRA carries a penalty of6% for every year it remains there,notes Thomas Gau, CFP®, CPA, withOregon Pacific Financial Advisors.

Journal

When you set up an inherited IRA,be sure to include the name of the personwho died, followed by "deceased" or"decedent," an indicator that the accountis still an IRA, and a statementthat it is "for the benefit of" the heir,including that person's name. Accordingto the article, the deadline forretitling an IRA is September 30 of theyear after the original owner's death.

Inheritance Options

Note:

When you inherit an IRA, youessentially have 2 choices: You cancash out the account as a lump sum orset up an inherited IRA and stretch outwithdrawals. Experts advise againsttaking the lump sum. Instead, youshould preserve (ie, stretch) an IRA tokeep from paying the income tax on itat once. Preserving an IRA spreads theincome across your lifetime and willmost likely increase the amount of theinherited IRA substantially. Ifyou decide on an inherited IRA, youmust begin taking annual distributionsby the end of the year after the originalIRA holder's death.

Changes in tax rules can also be overlooked.The federal government's newrules offer a reprieve for people whoinherited IRAs before 2002. In the past,if you didn't start taking payments byDecember 31 of the year following theoriginal IRA holder's death, you forfeitedyour right to lifetime distributions andhad to take them all within 5 years.

"Now, if you figure out how muchyou should have taken out and do it byDecember 31, the IRS will let you cureany mistakes and switch to the paymentmethod based on your own life expectancy,"says Steven Lockwood, presidentof Lockwood Pension Services inNew York. An accountant can help youmake the switch.

Another mistake heirs often make isforgetting that they can deduct anyestate tax already paid on an IRA theyinherit from their income tax bill. Theaccountant who did the estate taxreturn can figure out what part of theoverall bill was due to the IRA. You canthen include that portion with youritemized deductions.

If you are sharing an IRA amongsiblings or with a charity, experts recommendsplitting it up so that you benefitfully from the potential to stretchpayments across your lifetime. Beaware that there aren't that many financialadvisors with experience in IRAlegacies. So be careful from whom youget advice.