According to EBRI.org, in 2011 there were about $18 trillion dollars in retirement accounts. This includes pensions, 401(k) plans, IRAs, and other accounts. Unfortunately many owners of these accounts are not fully aware of the complicated tax laws regarding distributions on these accounts.
People usually focus on the investments in their accounts. While this is important, there are additional strategies they may be missing that can save money for the investors and their heirs in the long run.
Retirement accounts are different!
Retirement accounts must be in he name of the individual that put the money into the account. They cannot be held jointly. In my case, I have my IRA and my wife has her own IRA. Under normal circumstances I can’t transfer money to her account and she can’t transfer money into mine.
Like life insurance, beneficiary designations of retirement accounts override any will or trust, unless that will or trust is specified as the beneficiary. This is great news, because if you name a specific person to be a beneficiary, it would avoid the probate of a will. However, it is imperative that you consider planning for distribution of these assets.
Since IRA assets are significantly different from other assets in your estate plan, they can be very complex and cause mistakes. Many people jokingly call these “Individual Riddle Accounts” because of the complexity.
Some differences to keep in mind regarding IRAs:
§ They do not pass through the will (unless payable to an estate)
§ IRAs are not subject to probate (unless payable to an estate)
§ No capital gains treatment
§ No step up in cost basis up death
§ Cannot be gifted (in most cases)
§ The title cannot be transferred to a trust
§ Required Minimum Distributions.
People are often confused about required minimum distributions. IRA accounts may be the only assets where you must take money out each year. While this may increase the taxes you pay, do keep in mind that this money has been tax deferred since you contributed it and it has never been taxed.
Be careful and don’t put the title of an IRA into a trust. This may cause immediate taxation! This is just another way that retirement accounts are different.
Your heirs (children, grandchildren, etc) can receive what is called an Inherited IRA. This IRA allows the beneficiary to keep the account tax deferred, which can increase the amount withdrawn over their lifetime. Note that required minimum distributions may be required for the beneficiary even before age 701/2.
Naming beneficiaries and keeping the list updated when necessary is also important with retirement accounts. For example, in the case of a divorce, new beneficiaries may need to be chosen. There have been cases where the ex-wife inherits her ex-husband’s IRA even though he has remarried because he never updated his beneficiary.
Complicated tax laws have made working with retirement accounts very difficult. If things are not done properly, there could be taxes and penalties as a result. Errors with accounts can sting sometimes people who are knowledgeable in investments. Whatever you do, make sure you are working with a professional who is up to date on the tax laws regarding retirement distributions.
Just to complicate things even more, retirement accounts can be subject to two sets of rules:
1. The IRS’s rules
2. The IRA custodian or Retirement Plan Administrator’s rules
You must use the stricter of the two rules. Many people do not know that custodians do not have to be current with respect to allowing you to use provisions under the tax laws. While the IRS may allow a particular entitlement, your IRA custodian does not have to.
In addition to knowing all the rules and regulations of the IRS, it is additionally important to understand the rules of your IRA/Retirement Plan custodian or administrator. Differences between the two can sometimes lead to frustration or penalties. This crucial part of retirement planning is as important as your investment choices.