Lynn Brenner's Family Finance

Who Inherits an IRA That's Going Into a Trust?

Q: My dad, who has no Internet connection, asked me to ask you this question: Who will get his IRA if he passes? He is 88 years old, and has a living trust set up. I'm his oldest son and he has given me the executor role. He just read your article in the March-April 2010 issue of AARP magazine ('Who'll Get Your IRA?' ) that has given him some concern on how to handle the IRA. -- GL via email

 

A: If the IRA goes into the trust, the trust beneficiaries will get it. But how fast it must be distributed -- and taxed -- depends on how the trust is written.

First, a basic fact that's often misunderstood. The legal document that controls who gets your IRA is your beneficiary designation form. When someone says he is leaving an IRA `to my will', or 'to my living trust', he means either that he didn't fill out the IRA beneficiary form at all, or that he used the form to name his will or his trust as the beneficiary.

In either case, the result is that he has made his estate his IRA beneficiary. His will (or his living trust) directs how his estate is to be distributed.

It sounds as if your father has left his IRA to his living trust. And that creates a potential problem:

When you name a human being as your IRA beneficiary, that person can stretch withdrawals from the account over his or her own life expectancy. If your heir has a long life expectancy, that stretch-out can make a huge difference to the size of his or her inheritance.

Let's say you leave a $400,000 IRA to a 40-year-old, for example. He can stretch his required annual withdrawals from the account over another 43.6 years. (His first required minimum distribution would be $9,174 —$400,000 divided by 43.6.) He'd owe taxes on the withdrawals, but the IRA balance could keep growing untaxed for more than four decades.

Assuming an 8 percent annual return and minimum annual withdrawals, by the time he turned 65, the IRA would be worth almost $1.2 million, says Barry C. Picker , a Brooklyn NY IRA expert -- and in the meantime, he would have received $671,000 in annual distributions!

But it's a different story when you name a non-human beneficiary. Legally speaking, your estate expires when you do. It has no life expectancy, so it can't stretch out its withdrawals from the IRA. Instead, the IRA must be emptied within five years of your death, or on a schedule that's based on your remaining single life expectancy according to the Internal Revenue Service actuarial table -- depending on the age at which you died. (The five year rule applies if you were under 70 and a half when you died. The IRS single life actuarial table applies if you were over 70 and a half when you died.)

Either way, the IRA must be emptied much faster than if your kids were using their own life expectancies.

You can avoid this problem if the trust is worded properly. If it's written right, for tax purposes it becomes only a conduit to the human trust beneficiaries.  In that case, the IRA can be emptied over the life expectancy of the oldest trust beneficiary.

But your father doesn't have to worry about whether his trust is correctly worded.

There's a simple, cost-free way for him to make sure his IRA beneficiaries inherit the account in the most advantageous way. All he needs to do is to name them on his IRA beneficiary form. If he has already named his living trust, he can ask the IRA custodian for a new form and can change his beneficiary designation.

When your heir is a disabled or minor child who'll need help handling his inheritance, it makes sense to leave your IRA to a correctly worded trust (and to name a reliable trustee.) But otherwise, using a trust as your IRA beneficiary doesn't really provide any advantage -- and if it isn't done correctly, it could inadvertently hurt your survivors by making the IRA taxable much faster than necessary.

Please send your questions to Lynn@LynnBrennersFamilyFinance.com. I'm sorry I can't respond personally to every email. Questions are addressed only online.

(c) Lynn Brenner, All Rights Reserved.

 

       

What Is a Trustee-to-Trustee Transfer of an Inherited IRA?

Q: I have just read your advice on moving an inherited IRA by doing a 'trustee to trustee' transfer. I have no immediate need for this money, and I think I would like to do this. I've inherited two different accounts that will total about $20,000. I am 50 years old. My main question is 'what exactly is trustee to trustee'? Does this mean 'bank to bank'?  If I do this, will the money be in my name so I can take it out at a later date? --CF via email

 

A: First things first. Unless you inherited this IRA from your spouse, you can't put the money in your name. The original owner's name must stay on the IRA, with you listed only as its beneficiary.

That doesn't mean you won't be able to take withdrawals. In fact, if you aren't a surviving spouse, you must start taking withdrawals from this IRA by December 31 of the year after the original owner died, even if you don't need the money.

The bad news is that each withdrawal is taxable income. 

The good news is that you're not required to withdraw more than an annual minimum based on your life expectancy as it appears on the Internal Revenue Service actuarial table for beneficiaries. If you're 50 years old, your life expectancy is 34.2 years.

Your annual withdrawal must be based on the total IRA balance. If that total is $20,000, divide $20,000 by your 34.2 life expectancy ... and your first annual withdrawal is $584.79.

Okay -- what about moving the account?

'Trustee to trustee' means that the IRA's current custodian transfers the account to a new custodian. The transfer is done between the two companies and the money never touches your hands, even in the form of a check.

This is the only way a non-spouse IRA beneficiary can move the account without triggering a tax on it. If the bank gives you a check to deposit in another institution, the whole IRA automatically becomes taxable.

The IRA custodians don't have to be banks. You can move the IRA from a bank to another bank, or you can move it from a bank to any mutual fund company, stock brokerage, or insurance company.

But wherever you move this money, it must go into an IRA in its original owner's name.  Only a surviving spouse gets to put an inherited IRA into his or her own name. If any other beneficiary does that, the account stops being an IRA and becomes ... that's right, immediately taxable.

Here's how you do a trustee to trustee transfer:

The IRA is currently in two accounts, one at Bank A and one at Bank B. Let's say you decide you want to move both accounts into a single IRA at Mutual Fund Company X.

First, you must open a brand-new IRA at Mutual Fund Company X.

Be sure to ask for the paperwork to open an inherited IRA, and make it clear that you are not the surviving spouse. (Many IRA custodians automatically hand out the forms to open an IRA in your own name. That's not what you want!) Fill in the name of the new IRA: For example, if you inherited Jane Smith's IRA and your name is Catherine Freeman, the account will be 'Jane Smith IRA (deceased December 14, 2009) for the benefit of Catherine Freeman'.

There's a space on the IRA form to say how you're going to fund this new account. That's where you say it is to be funded with 100% of the proceeds of the accounts at Bank A and Bank B. You'll fill in those account numbers.

Mutual Fund Company X is then responsible for getting Bank A and Bank B to transfer the money into your new IRA. If there are any delays -- if Bank A wants you to confirm independently that you've authorized the transfer, for example -- Mutual Fund Company X will tell you what you need to do to speed the transfer along. It will also tell you when the transfer is completed.

You can invest the IRA in any of the choices offered by Mutual Fund Company X. (And if Mutual Fund Company X has a discount brokerage affiliate -- as Vanguard Group and Fidelity Investments do, for example -- you can invest it in virtually any mutual fund offered by any other company.)

You must recalculate your required annual withdrawal every year. You'll find the actuarial table -- 'Single Life Expectancy Table for Use by Beneficiaries' -- at the back of IRS publication 590. You can download it here.

Of course, you can take out more than the minimum if you want. Only the withdrawals are taxable; the balance grows tax-deferred.

Please send your questions to Lynn@LynnBrennersFamilyFinance.com. I'm sorry I can't respond personally to every email. Questions are addressed only online.

(c) Lynn Brenner, All Rights Reserved.

Can I Claim My Late Husband's 401(k) Account, Even Though He Left It To His Parents?

Q: My husband recently died and he left his Mom and Dad as the beneficiaries for his 401(k).  Do I have any legal grounds to contest this, and will I need an attorney to do so? -- LH via email

A: You certainly do have grounds to contest this -- and it shouldn't take a lawyer. You're legally entitled to this money. There's no gray area here.

Call the 401(k) plan's administrator immediately and tell them you are the plan participant's surviving spouse. By federal law, you are entitled to be your husband's 401(k) beneficiary, says Lisa Arko, an employee benefits consultant at Towers Watson in New York City. Your spouse can't name someone else unless you have consented in writing to waive that right.

(And in case you're wondering, that waiver can't be part of a prenuptial agreement. A prenuptial agreement can only address rights you actually have -- and you have no legal right to be your mate's 401(k) beneficiary until after your marriage.)

It's entirely possible that your husband had named his parents as his beneficiaries before you were married, and simply failed to update his 401(k) paperwork after the wedding. That seems likelier than that he would designate them as beneficiaries after your marriage without first obtaining your written consent.

But it makes no difference how this happened. You are legally entitled to this money. The 401(k) plan administrator will be very aware of this, and should respond immediately. The last thing they'll want to do is pay the wrong beneficiary!

Please send your questions to Lynn@LynnBrennersFamilyFinance.com. I'm sorry I can't respond personally to every email. Questions are addressed only online.

(c) Lynn Brenner, All Rights Reserved.

Don't Make Your Estate Your IRA Beneficiary

Q: My mother had an IRA and the IRA beneficiary is her estate.  However, her will leaves everything, including the IRA, equally divided between my sister and me.  Since we were not the actual beneficiaries on the IRA, what is our best course of action to reduce tax exposure?  I’ve seen a lot of documentation on how to handle an IRA if you are the beneficiary, but since the estate is the beneficiary, the attorney handling her will says it makes a difference to us. -- CS via email


A:   Your lawyer is right. The rules are different when the estate is the IRA beneficiary.

In fact, there are three sets of rules for inherited IRAs. The first applies only to beneficiaries who are surviving spouses. The second applies to all non-spouse human beneficiaries -- i.e., children, siblings, friends. And the third applies to non-human beneficiaries like estates and charitable organizations.

A surviving spouse can transfer an inherited IRA into an IRA in his or her own name, and thus postpone taking taxable distributions from the account until after turning 70 and a half.

But no other heir can transfer your IRA into a new account in his or her own name. They must start taking distributions after your death. The big question is, how fast must they empty the account? A lot of money rides on the answer, since the longer they can postpone taking money out of the IRA, the longer it can keep growing untaxed.

If the designated IRA beneficiaries are human beings, they can take minimum annual distributions based on their own life expectancies. But in your case, the IRA beneficiary is your mother's estate -- and it has no life expectancy. The result: 

If your mother was under 70 and a half when she died, her IRA must be emptied within five years of her death. If she was older -- and therefore already taking mandatory IRA distributions -- you and your sister can empty the account over her remaining life expectancy, as defined on the Internal Revenue Service 'Single Life' actuarial table for IRA owners. You'll find that table in the index of IRS Publication 590, which you can download at www.irs.gov.

Please send your questions to Lynn@LynnBrennersFamilyFinance.com.  I'm sorry I can't respond personally to every email. Questions are only addressed online.(c) Lynn Brenner, All Rights Reserved