Stretching an Individual Retirement Account
Inheriting an Individual Retirement Account can be a financial godsend.
If an IRA is stretched out for a long period of time, it can continue growing well beyond its original size. Various pitfalls, however, keep many IRAs from lasting as long as they could.
Here are a few of the ways to make sure that you or somebody else never sabotages your IRAs:
1. Double-check your beneficiaries.
Don’t leave your IRAs to the wrong person. You probably wouldn’t want to bequeath your hard-earned money to your ex-spouse and you also would not want to intentionally stiff one of your kids or perhaps a grandchild.
Yet it’s easy for this to happen. When you establish an IRA, you’re supposed to fill out a beneficiary form. But once that document is signed, many people never think about it again. You need to revisit these forms, however, if there is a birth, death, marriage, divorce, or other change affecting who you want the IRA to go to.
One reason why these beneficiary forms aren’t kept current is because people commonly assume that their wills direct who receives their IRAs.
But that’s a wrong assumption. For example, if your will says that your present spouse will inherit your IRA, but your IRA beneficiary form still lists your ex-spouse, it’s the ex who will strike gold.
If you want to avoid tragic mistakes like that, update your beneficiary forms as circumstances change and keep copies of the beneficiary forms in your estate-planning files.
2. Don’t name your estate as an IRA beneficiary.
If you want your IRA to live long after you’re gone, don’t designate your “estate” as the beneficiary of your IRA.
What will happen if the estate is designated instead of a person? The IRA’s fate will depend upon the timing of your death. If an IRA owner dies before he or she begins taking required minimum distributions – this will occur shortly after someone turns 70 1/2 – the IRA must be disbanded at the end of the fifth year following the year of the person’s death.
If the owner was already started taking required minimum distributions, the heirs could take payments over the deceased’s remaining life expectancy. Some financial institutions, however, won’t let you keep the IRA on temporary life support and will force you to take the full amount all at once, which will, of course, trigger unwanted income taxes.
3. Divide an IRA properly.
An inherited IRA can grow substantially over time if a beneficiary only withdraws the minimum amount that’s required by the Internal Revenue Service each year.
If you want to capture the longest stretch, you should understand how an IRA can be divided when multiple people inherit one. One way to achieve the maximum stretch is to make sure an IRA gets carved up into separate accounts either before or after the owner’s death. Loved ones, who inherit an IRA, have until Dec. 31 of the year following the death to split an IRA among themselves.
If the IRA isn’t divided into separate shares (accounts), all the beneficiaries are stuck with an IRA payout schedule that is based on the age of the oldest beneficiary. Obviously, it’s better for the youngest heirs, who would be forced to drain their portion of the inheritance prematurely, to get the IRA split into separate accounts.
4. Keep the stretch going for a third generation.
If you were lucky enough to inherit an IRA, take a few minutes to make sure the IRA gets passed on to someone else if you should die before the account is emptied. After inheriting an IRA, you should name a successor beneficiary, who could continue to stretch the IRA for the remaining time on its clock.
For instance, if you had a 30-year life expectancy when inheriting a parent’s IRA and you die 20 years later, your daughter, if she was named a successor beneficiary, could continue pocketing the IRA payments for 10 more years.
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