Don’t Overlook Beneficiary Designations In Your Estate Planning

I’ve written previously about the importance of making sure that you have beneficiaries designated for assets such as life insurance and retirement accounts. Proper beneficiary designations are a key component of estate planning. Naming beneficiaries of certain assets, like life insurance or retirement accounts, is the most effective way to make sure assets pass to the intended parties upon your death in the most efficient way possible.

Unfortunately, many people make the mistake of overlooking this important aspect of estate planning. Failing to designate beneficiaries, or not keeping beneficiary designations up to date can result in assets being subject to the expense and delay of probate.

WealthManagement.com has a short, but very good article on the importance of beneficiary designations in your estate planning. Please take a few minutes to read the article here.

The Markets are Declining; Is It Time to Convert to a Roth IRA?

The last few weeks have been pretty dismal for investors.  (As of this writing, the Dow Jones Industrial Index is down about 2,000 points from its 2015 highs.) No one likes to see the value of their retirement accounts decline, but long-term investors know that market declines are inevitable. One of the keys to successful long term investing is the ability to use market declines to one’s advantage.

Declining markets present a great opportunity to convert a traditional IRA to a Roth IRA. Once converted, the funds in the Roth grow tax fee, are not subject to minimum distribution rules, and may be withdrawn 100% tax free.

To convert a traditional IRA to a Roth, you must pay income tax on the amount converted. If you were to convert an $80,000 traditional IRA to a Roth, $80,000 would be added to your income for tax purposes. But as markets have fallen recently, so too have IRA account values. A traditional IRA worth $80,000 several weeks ago may only be worth $60,000 today. That would be $20,000 less income subject to tax on the conversion. If your IRA has decreased in value, you can convert the account balance (or a portion) to a Roth and lock in a lower tax bill before the markets turn back upward.

But, the markets may decline even lower and so too, the post-conversion value of the Roth IRA.  Or, maybe you completed a Roth conversion earlier in 2015 before the markets began to fall.  Fortunately, you have the ability to undo (recharacterize) the Roth conversion, eliminating the tax otherwise due. (If you converted a traditional IRA to a Roth at any time in 2015, you have until October 15, 2016, to recharacterize it and avoid the taxes.) After the recharacterization you can reconvert the IRA to a Roth at the lower account value, paying even less tax than you would have on the original conversion. However, reconversions are extremely complex and require proper timing to avoid running afoul of the complicated tax rules that apply.

In the right situation, market declines can present substantial planning opportunities with IRAs. Remember, the rules governing IRAs are complex, and a Roth IRA conversion or recharacterization done incorrectly can result in disastrous tax consequences.

Your situation is unique. Please do not rely on the information contained in this article as it may not apply to your situation. Before making any move with any type of retirement account, consult your CPA or other tax adviser, or contact me. I can help.

3 Popular Retirement Planning Loopholes That May Be Closed

Advisers have plenty of tricks and techniques to help clients maximize retirement savings and income, and minimize taxes. Many are considered “loopholes” in existing laws that advisers and their clients exploit to great advantage. Unfortunately, when use of these loopholes becomes too widespread, the government steps in to close them. This may happen soon to 3 popular retirement planning techniques according to a recent Reuter’s article.

The “stretch” IRA. Beneficiaries of an IRA or other retirement accounts have the option of taking distributions from the inherited account over their remaining life expectancies. And in the case of Roth IRAs, this means a lifetime of tax free distributions. Lawmakers on both sides of the political isle don’t like this. They believe that retirement accounts should be for retirement – not a tax windfall for heirs.

Law changes have been proposed in Washington that would require the balance of an inherited retirement account to be paid out to beneficiaries within 5 years of the account owner’s death. In the case of a traditional IRA, the acceleration of distributions will increase the income taxes that beneficiaries will pay on the distributions.  People contemplating Roth conversions for the benefit of children or other heirs may need to rethink this strategy if the beneficiaries have to withdraw the funds within 5 years.

Back-door Roth IRA conversions. The law creating Roth IRAs contains restrictions that prohibit certain high-income individuals from contributing to a Roth IRA. However, the law contains a loophole that allows these high-income earners to make a non-deductible contribution to a traditional IRA, and then convert the funds to a Roth IRA. In a typical transaction of this type, zero income tax has to be paid on the conversion. Once converted, the funds grow income-tax free and no tax is due on distributions from the account, which lawmakers believe hands beneficiaries an unintended tax-free windfall.

Aggressive Social Security benefit claiming strategies. One of these likely to be ended is known as “file and suspend.” Married couples can claim benefits based on their own work record or on the work record of their spouse. A person who reaches full retirement age (currently 66) can apply for their own retirement benefit and then immediately “suspend” the application so that their monthly benefit continues to grow until they reach age 70, when they must begin collecting. If their spouse is also at full retirement age and hasn’t claimed their own retirement benefit yet, the spouse can apply for a spousal benefit, which can be as much as ½ of their partner’s monthly retirement benefit. He or she can collect the spousal benefit until age 70 and then switch to their own monthly retirement benefit.

Experts opine that people who are already receiving Social Security benefits or those close to retirement age probably don’t have to worry. The government isn’t likely to take back something that has already been given. Changes will likely have to be phased in to avoid political backlash. Government gridlock may also prevent anything from happening soon.

See Liz Weston, Three retirement loopholes seen likely to close, Reuters, June 29, 2015.

My Siblings And I Inherited Our Dad’s IRA, Now What?

A prospective client contact me regarding the disposition of an IRA account he and his siblings inherited from their father. They wanted to know what had to be done now that they were to receive the IRA funds.

Many people will name multiple beneficiaries to an IRA or other retirement account. They’ll do this when they want the account balance to go to more than one person, but they don’t want to incur the additional fees or paperwork by maintaining separate accounts for each beneficiary. While it makes things easier for the account holder, handling the IRA after his death can be very a complex task for the beneficiaries.

The first step is to split the IRA into separate accounts, one for each sibling named as a beneficiary. The due date for splitting an IRA is December 31 of the year following the year of the account owner’s death. In this case, because the father died in 2015, the children have until December 31, 2016, to split the IRA into separate accounts.

The December 31 deadline is important because it allows each beneficiary to “stretch” distributions from his or her separate account over their own remaining life expectancy. This can be important where there is a large age difference from the oldest to the youngest beneficiary. If the deadline is missed, money must be withdrawn from dad’s IRA based upon the life expectancy of the oldest designated beneficiary.

This split must be done by direct transfer. Non-spouse beneficiaries may not roll over a deceased account owner’s IRA. Each new “inherited” IRA account must also keep the deceased account owner’s name on the account.

Once the split is completed, each beneficiary must begin taking distributions from his or her inherited IRA account by the same December 31 account splitting deadline to take advantage of the life expectancy method of distribution. In this case, they must begin taking distributions out by December 31, 2016. The life expectancy method allows a beneficiary to maximize tax deferred growth of the balance of the IRA account over their remaining lifetime.

Seems very simple. But the rules governing IRA and other retirement account distributions are very complex. Even something as seemingly simple as splitting up an IRA or other retirement account can be done incorrectly, resulting in disastrous tax consequences.

Your situation is unique. Please do not rely on the information contained in this article as it may not apply to your situation. Before making any move with an IRA or any other type of retirement account, consult your CPA or other tax adviser, or contact me. I can help.

How to Take an IRA Required Minimum Distribution in 5 Steps

What is a required minimum distribution*, or “RMD,” you ask? An RMD is the minimum amount that must be withdrawn from an IRA or other retirement account each year. Failure to withdraw the required minimum amount by the annual deadline will cause you to incur a hefty penalty equal to 50% of the amount that should have been withdrawn from the account.  (*Sometimes referred to as a “minimum required distribution,” or “MRD.”)

In general, owners of traditional IRAs must start taking RMDs beginning with the year they turn age 70½. Beneficiaries of both traditional and Roth IRAs are required to begin taking RMDs the year following the year of the account owner’s death, if they do not elect to take a lump sum distribution.

Step 1: Determine the distribution year. The distribution year is the year for which the RMD is being calculated. This may not be the year in which the RMD is actually taken. A person turning age 70½ in 2015 does not have to take their 2015 RMD until April 1 of 2016. But if he does wait until 2016 to take the 2015 RMD, he must still take an RMD for 2016. After the year the IRA owner turns 70½, all subsequent RMDs must be taken by December 31 of each year.

Step 2: Determine the account balance. One must use the account balance as of December 31 of the prior year, adding back any outstanding rollovers and recharacterizations. For example, to determine the RMD for 2015, the account balance as of December 31, 2014, is used.

Step 3: Determine the applicable distribution period, or “ADP.” Most IRA owners will use the Uniform Lifetime Table to determine their ADP. If the IRA owner is married and his spouse is more than 10 years younger than he, the Joint Life Expectancy Table is used. In most situations, account beneficiaries determine their ADP for the year following the year of the account owner’s death using the Single Life Table. The ADP is the divisor used to determine the RMD for the distribution year. Whether determining the ADP for the account owner or an account beneficiary, one must use the age he or she will be at the end of the distribution year. For some RMD types, the ADP is recalculated each year. For other RMD types, the ADP is determined once, in the first distribution year, and reduced by one each year thereafter.

Step 4: Divide the account balance by the ADP. The result is the RMD that must be taken for the distribution year.

Step 5: Withdraw the RMD on time to avoid penalty. If the RMD is for the year in which the account owner turned age 70½, the RMD must be withdrawn by April 1 of the following year. In all other situations the RMD must be withdrawn by December 31 of the distribution year.

It seems very simple. But the rules governing IRA and other retirement account distributions are very complex. Even something as seemingly simple as taking an RMD from an IRA or other retirement account can be done incorrectly, resulting in disastrous tax consequences.

Your situation is unique. Please do not rely on the information contained in this article as it may not apply to your situation. Before making any move with any type of retirement account, consult your CPA or other tax adviser, or contact me. I can help.

 

You Can’t Do That! 5 Prohibited IRA Transactions.

5 (of many) things you cannot do with your IRA – ever:

1. Transfer an IRA to a spouse. Unless incident to a divorce judgment, you may not transfer an IRA to your spouse. Doing so creates a taxable distribution. (Oh, and you can’t transfer it to anyone else either.)

2. Retitle your IRA to your trust for estate planning purposes. Only individuals can own an IRA. Your trust is not an individual. So, changing the owner of your IRA from you to your trust is a taxable distribution.

3. Pledge your IRA as security for a loan. You are not allowed to use your IRA as collateral for a loan. If you do, you’ve made a “deemed” distribution from the IRA, a taxable event.

4. Lend money from your IRA to yourself or a family member. IRAs are prohibited from lending money to any “disqualified persons.” “Disqualified persons” include the account owner, members of the IRA owner’s family, and certain business entities owned by the IRA owner.

5. Invest IRA funds in collectibles. “Collectibles” include artwork, antiques, gems, stamps, and coins (with certain narrow exceptions). Any IRA funds invested in collectibles are deemed to have been distributed from the IRA, a taxable event.

Generally, when IRA assets are used in a prohibited transaction, the IRS treats them as having been distributed from the IRA on the first day of the year in which the transaction took place. The amount of the distribution must be included in the IRA owner’s income for that year and, if the owner is under age 59½, early distributions penalties will apply.

4 Key Rule Changes Affecting Retirement Accounts You Need to Know.

What you don’t know can hurt you. And this truism is never more apt than when it comes to the rules governing retirement accounts. Several rule changes took effect recently that will have a significant impact on traditional and Roth IRAs, and employer sponsored retirement plan accounts. Individuals who own these types of accounts must become familiar with the following new rules now:

1. As of January 1, 2015, IRA owners are limited to one rollover per year.

Under this new IRS rule, an IRA owner can take a distribution from an IRA and roll it over into another IRA account only once per 12 month period, regardless of how many IRA accounts he may own. This rule aggregates traditional IRAs and Roth IRAs together, so one cannot perform a rollover between traditional IRAs and then perform a rollover between Roth IRAs within the same 12 month period. This is a significant change to the way the IRS has treated multiple rollovers generated by a 2014 United States Tax Court decision. Violate this rule and the second rollover will be treated as a taxable distribution, which will result in the imposition of income taxes (and the dreaded 10% early withdrawal penalty if the account owner is younger than age 59½).

Excepted from this new rule are direct trustee-to-trustee transfers, rollovers from employer sponsored qualified plans [such as 401(k), 403(b), etc.], and Roth conversions.

2. Inherited IRAs are not protected in bankruptcy.

In 2014 the United States Supreme Court ruled that funds in an inherited IRA are not protected in bankruptcy from the claims of the IRA beneficiary’s creditors unless a state law provides a specific exemption (currently only a few states provide this type of exemption, and Michigan isn’t one of them). Individuals with larger IRA or qualified plan account balances may need to rethink their retirement account beneficiary designations in light of this ruling. In circumstances where a child or other beneficiary may have financial trouble, it may be prudent to make other arrangements to enhance creditor protection for inherited account balances.

3. QLACs get the go-ahead.

What is a “QLAC?” It is a qualified longevity annuity contract, which can enhance income security for those  who may be worried about outliving their money in retirement. These deferred income annuities can be purchased through IRAs and qualified plans (within limits) and the contract values will be exempt from RMD rules until age 85, when distributions from the QLAC must begin. A QLAC will do two things: First, distributions from the account can be delayed until age 85, thus allowing for greater tax deferred growth and guarantying an income stream for life; and second, the value of the annuity will be excluded when calculating required minimum distributions (RMD) from other retirement accounts (and the payments from the QLAC are assumed to satisfy its RMD obligation).

To be eligible, a QLAC must meet the following criteria: i) Investment in the contract is limited to the lesser of 25% of all pre-tax retirement account balances aggregated together, or $125,000 (indexed for inflation); ii) The QLAC must begin its pay outs no later than age 85; iii) The QLAC must be irrevocable and illiquid (no cash-surrender value), but it can provide for a return-of-premium death benefit payable to heirs as a lump sum or life-contingent survivor annuity; and iv) it must be a fixed income annuity – variable annuities, indexed annuities, and similar type annuities will not qualify.

4. IRS Notice 2014-54 allows for the tax-free conversion of after-tax funds from a 401(k) account to a Roth IRA.

Under this IRS Notice, the IRS confirms that individuals with both pre and after-tax money in an employer sponsored retirement plan can convert the after-tax money to a Roth IRA tax free. However, one may not simply take out the after-tax money for the Roth conversion and leave only pre-tax money behind in the employer plan. If they do, the IRS will apply the traditional pro-rata rules to the distribution.

The rules governing IRAs and other retirement accounts are very complex and tricky. Even seemingly simple transactions involving an IRA or other retirement account can result in disastrous tax consequences. And the Internal Revenue Code is extremely unforgiving. Before making any move with any type of retirement account, consult your CPA or other tax adviser, or contact me. I can help.

New Once-Per-Year Rule On IRA Rollovers Looms

Beginning January 1, 2015, IRA owners will be limited to one IRA rollover per year under a new Internal Revenue Service rule. The IRS issued the rule in response to a recent US Tax Court decision which held that multiple rollovers between different IRAs owned by the same taxpayer violated the Internal Revenue Code. The new rule will be applied prospectively and will impact taxpayers owning more than one traditional IRA or Roth IRA.

Under the new IRS rule, an individual receiving an IRA distribution on or after January 1, 2015, cannot roll over any portion of the distribution into an IRA if the individual has received a distribution from any IRA (whether a traditional IRA or Roth IRA) in the preceding 1-year period that was rolled over into an IRA. The new aggregation rule, which takes into account all distributions and rollovers among an individual’s traditional and Roth IRAs, will apply to distributions from different IRAs only if each of the distributions occurs after 2014. This creates a special transitional safe harbor for those taxpayers who received a distribution from an IRA in 2014 and properly rolled it over into another IRA. Such a rollover will be disregarded for purposes of whether a 2015 distribution can be rolled over, provided that the 2015 distribution is from a different IRA that neither made nor received the 2014 distribution.  This gives IRA owners a fresh start in 2015 when applying the one-per-year rollover limit to multiple IRAs.

A conversion from a traditional IRA to a Roth IRA is not subject to the aggregation rule, and such a rollover is disregarded in applying the one rollover per year limitation to other rollovers. Note, however, that a rollover between an individual’s Roth IRAs would preclude a separate rollover within the 1-year period between the individual’s traditional IRAs, and vice versa.

The one-per-year rollover limitation does not apply to a rollover to or from a qualified plan [such as a 401(k) or 403(b)] (and such a rollover is disregarded in applying the one-per-year rollover limitation to other rollovers). More importantly, it does not apply to direct trustee-to-trustee transfers.

This rule will certainly encourage taxpayers to make direct trustee-to-trustee transfers when moving money between IRA accounts.  Trustee-to-trustee transfers expressly avoid the new rollover aggregation rule.

The rules governing distributions from IRAs and other retirement accounts are very complex, and very tricky. Even seemingly simple transactions involving an IRA or other retirement account can result in disastrous tax consequences. And the Internal Revenue Code is extremely unforgiving. Consult your CPA or other tax adviser, or give me a call. I can help.

Never Assume – Here’s Another Reason Why.

People can be surprisingly nonchalant when it comes to beneficiary designations on retirement accounts and life insurance policies. They assume even if they have missed a beneficiary designation or it is out-of-date, the remaining account balance will automatically go to their surviving spouse or children upon death.

However, a recent survey done by the National Investment Company Service Association (NICSA), reveals that there is little consistency among IRA providers as to how default IRA beneficiary designations are handled. According to the survey, the default beneficiary will vary widely depending on the provider. For example, 43% of accounts default to a surviving spouse, then the estate; 30% default to the account owner’s estate (not a spouse or children); and only 22% percent default automatically to a spouse, then the children, then the estate. To complicate matters, many people have multiple IRAs at more than one institution, which means the default beneficiary treatment of each account will vary.

A beneficiary designation on an IRA or other retirement account is critical because retirement accounts are automatically excluded from an account owner’s probate estate as long as the account has at least one person designated as the beneficiary who survives the account owner. If there is no then living beneficiary, the account is deemed to have no beneficiary and it must be paid to the deceased owner’s estate. This has two very bad effects: First, a probate estate has no life expectancy and, consequently, the account has to be liquidated, which can result in a significant income tax bill; Second, because the account must be paid to the owner’s estate, it becomes subject to the claims of the owner’s creditors – and the creditors enjoy a prior right to the funds ahead of surviving family members, even a spouse.

IRA providers will include default beneficiary designation clauses in their account agreements so that if the account owner fails to designate a beneficiary before death, or the designated beneficiary dies before the account owner, the balance in the account will still pass to a default beneficiary per the account agreement. But as the survey shows, you cannot assume who that beneficiary is, and there’s a nearly 1-in-3 chance the default beneficiary will be the owner’s estate.

I’ve seen too many cases where a retirement account or life insurance benefits passed to an unintended beneficiary, and it’s next to impossible to correct something like that after the owner’s death.

One of the homework assignments I give to all of my planning clients is to verify all of their beneficiary designations on each of their retirement accounts and life insurance policies. It is very common for clients to come back to my office having discovered that they missed a beneficiary designation or one or more were out-of-date. At least they have a chance to correct them.

So, don’t leave it to chance. Do your homework and make sure your beneficiary designations are up to date.

December 31 Deadline Approaches For Mandatory Distributions From IRAs.

The December 31 deadline for taking required minimum distributions (RMDs) from individual retirement accounts is approaching.  One either takes the mandatory RMD from their IRA by year end or suffers the 50% excess accumulations penalty (plus interest!) on any required withdrawals that aren’t taken.

Generally, an IRA owner who is at least age 70½ must take an RMD from an IRA by December 31, 2014, with one exception. If the IRA owner happened to reach age 70½ in 2014, he can delay taking the 2014 RMD until April 1, 2015. But remember, if the distribution is delayed to next year, the IRA owner will have to take two distributions in 2015. (For those with substantial taxable income, delaying the 2014 distribution may have a significant impact on their income taxes for 2015, so proper planning is a must.)

So, who has to take an RMD from an IRA before year end? Let’s take a look at some of the more common situations:

If the owner of a traditional IRA is at least age 70½ by December 31, he must take a distribution. (But, if he did reach age 70½ this year, he can delay taking this year’s RMD until April 1, 2015.) (Roth IRA owners do not have to take RMDs – a prime benefit of a Roth IRA.)

For a non-spouse beneficiary of a traditional IRA, an RMD must be taken by year end – regardless of her age – if the account owner died before 2014.

For the surviving spouse who is the sole beneficiary of a traditional IRA, an RMD must be taken in 2014 if the deceased account owner would have reached age 70½ this year. If the account owner died in 2014 and he was age 70½ or older, the spouse beneficiary will have to take an RMD in 2015, the year after the account owner’s death.

If a taxpayer is under age 59½ and has set up a §72(t) distribution plan (“Series of Substantially Equal Periodic Payments”) from her IRA, she must take her full distribution by year end.

If an IRA owner died after April 1, 2014, and he was at least age 70½ at the time of death, he will have an RMD for 2014. The RMD must be taken by the account beneficiary if a beneficiary was designated. If no beneficiary was designated, the RMD is payable to the IRA owner’s estate.

We have focused only on traditional IRA accounts in this post. Special rules apply with regard to RMDs from multiple IRA accounts, and RMDs from other types of retirement accounts such as 401(k) and 403(b) accounts, which simply cannot be addressed here in a single post.

The rules governing required minimum distributions from IRAs and other retirement accounts are many, complex, and tricky.  If you are not sure whether you must take an RMD from an IRA or other type of retirement account this year, or how much to take out if you do, please consult with your tax advisor, or give me a call. I can help.