By: Elliot Raphaelson
Because most employers have eliminated defined-benefit retirement plans, future retirees will depend more than ever on 401(k) plans, traditional IRAs and Roth IRAs.
To plan for a successful retirement, you must understand the fundamentals and nuances of these plans. The regulations are complex, and you cannot afford to make any mistakes. Not every financial planner is well-educated in this field. If you depend on a financial planner, make sure he/she has the required expertise. Don’t be afraid to ask a prospective planner to demonstrate it.
Before you do that, you need to educate yourself. I recommend Ed Slott’s “Retirement Decisions Guide” for 2018, available for $13 through IRAHELP.COM (or by calling 1-800-663-1340).
Regular readers of this column will recognize Slott’s name. He’s a leading expert on IRA planning, and I cite him frequently. Recently, I attended a two-day seminar for financial advisers sponsored by his company. One of the insights I came away with is the importance of designating the IRA’s beneficiaries.
One of the most important features of an IRA is the ability to extend its life as long as possible to take advantage of the associated tax advantages. Many choose to include children as beneficiaries as a way to create a “stretch” IRA.
A beneficiary who inherits and IRA will be required to make age-related withdrawals. The older an individual is, the greater the required mandatory withdrawal. Accordingly, children who are beneficiaries can stretch out the required withdrawals for a longer time frame than a spouse. If your children are in a lower tax bracket than your spouse, that would be another advantage.
A major reason why attempts to create a stretch IRA fail is that the individuals who set them up fail to name a living beneficiary. It’s that simple.
Too many people believe that IRA succession is taken care of or covered in the will or estate plan. It isn’t. Wills do not cover IRAs! The IRA passes outside the will by beneficiary designation. That designation is retained by the financial institution that maintains your IRA account.
If the financial institution you established your IRA with merged with another financial institution, your initial form establishing beneficiary designation may not have been retained by the new firm. It is your responsibility to ensure that the new financial institution has an up-to-date beneficiary designation form. If your financial institution does not have a written designation, then your estate will be the beneficiary, and your beneficiaries would lose the stretch option.
If a life event occurs that alters your choice of beneficiary, you must update your beneficiary designation forms. Changing your will is not sufficient! If you go through a divorce, and you don’t want your ex-spouse to be a beneficiary, you must update the designations. If one of your beneficiaries dies, it is likely you will want to update the designations. Again, these changes have to be made via the beneficiary form, not your will.
After you die, how can your beneficiaries maximize the use of the stretch option? Only spouse beneficiaries have the option of rolling over the inherited IRA into their own IRA. Your spouse also has the option of initially establishing an inherited IRA and subsequently rolling it over into his/her own IRA. This makes sense for beneficiaries who inherit before age 59 1/2.
Suppose a widow inherits her deceased husband’s IRA before age 59 1/2 and rolls it immediately into her own IRA. If she withdraws funds, she will be subject to a 10 percent penalty. However, if she maintains it as an inherited IRA and withdraws funds from it, the 10 percent penalty is avoided. At 59 1/2, she can roll the account over to her own IRA. Withdrawals from traditional IRAs will be subject to income taxes on both inherited IRAs and individually owned IRAs.
Inform your beneficiaries, preferably in writing, of the steps they should take to transfer the assets to their accounts, or specify a financial planner they should be communicating with. If your beneficiaries don’t transfer the accounts in a timely manner, thousands of dollars will be lost.
A retired executive of Chase Manhattan bank, Elliot Raphaelson joined The Savings Game after decades of experience as an advisor, teacher and author in the field of personal finance. His writing has appeared in The New York Times, Town & Country, Vogue, Self, Savvy and Working Woman magazines. For ten years he has worked as a certified mediator and trainer in a Florida county court.