Lynn Brenner's Family Finance

Where to Keep Your IRA Beneficiary Forms

My May 12 post explained why IRA beneficiary designation forms are so important: They're the equivalent of a will for your IRAs.

I suggested that your safe deposit box is a good place to keep these forms. But I didn't make it clear that what you should keep are copies. The original forms must be filed with the IRA custodian -- i.e., the bank, brokerage, mutual fund company or other financial institution that holds the account.

Barry C. Picker, a Brooklyn NY tax accountant and IRA expert, points out that a hasty reading of my earlier post might lead some readers to the erroneous conclusion that it's okay to fill out a beneficiary form, sign it, and put it in your safe deposit box without ever submitting it to the custodian.

That could be disastrous!

"Say you filled out a form naming your son and sent it to the custodian. Now you change your mind and create a document naming your daughter, sign it, put it in your safe deposit box, but never submit it to the custodian. I don't think the daughter will get it," says Picker. "Definitely not without a fight from the son. I think what's on file with the custodian will trump it."

Just to make sure there are no misunderstandings about something so important, here's a step-by-step guide:

1. Ask your IRA custodian for a new beneficiary designation form and fill it out. (This is the easiest way to make sure you'll have a copy of the form, even if you aren't going to name a new beneficiary.)

Some custodians let you download or even complete this form online. Others simply ask you to send them written instructions, specifying the name of your beneficiary, his or her birth date and Social Security number, your relationship (e.g., spouse, son, daughter, friend), and the percentage of the account this person is to receive.

2. Make a copy of what you send the custodian, for your own records. You need this copy to prove that you submitted one, in case the custodian loses it.

3. Write a cover letter to go with the form. In your cover letter, you'll ask the custodian to send you written confirmation that he has received your beneficiary designation form.

4. Make a copy of the cover letter for your own records.

5. Send the original beneficiary designation form, along with the cover letter, to the IRA custodian.

6. Stay on top of the situation by making sure you receive that written acknowledgement.

6. Put your copy of the form, your copy of the cover letter, and the custodian's letter of acknowledgement in a safe place. It doesn't have to be a safe deposit box. But wherever it is, you should make sure that your executor and/or your lawyer knows where to find it.

You can change your IRA beneficiary designation as many times as you wish. Just make sure you always date it, and always have a copy of the current form.

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.

When IRA Beneficiary Forms Are Missing, Who Inherits?

Q: You’ve written about the importance of IRA beneficiary designation forms, and about how banks and brokers sometimes lose them. What happens if my children can't find my IRA beneficiary forms after I’m dead? Does it mean that they won’t inherit the account? –LR via email

 

A: Not necessarily. They may still get your IRA, depending on how your will is worded. But they'll have to empty the account and pay taxes on it much faster than they would if they’d inherited it as the designated beneficiaries.  

Let’s start with the ideal: Imagine you leave a $400,000 IRA to your 40-year-old daughter, naming her on the beneficiary designation form, which you keep in your safe deposit box, attached to your will with a paperclip.

As the designated beneficiary, your daughter can stretch her annual withdrawals from the account over her 43.6 year life expectancy. (Her first required minimum withdrawal would be $9,174 -- $400,000 divided by her 43.6. life expectancy) Her withdrawals are added to her taxable income every year,  but the IRA balance keeps growing untaxed. If she takes only the minimum required distributions every year and earns a decent investment return, the IRA could be worth more than $1 million by the time she's 65.

The less happy version: Your IRA beneficiary form is missing. Your estate is the default beneficiary. If your will says that your daughter inherits your estate, she still gets the IRA – but not on such favorable tax terms because your estate is the designated beneficiary, and it has no life expectancy over which to stretch distributions.

How quickly the IRA must be emptied in this case depends on your age when you died.

 If you were younger than 70 and a half, the law says the IRA must be emptied within five years of your death. If you were older than 70 and a half , it must be emptied over what the IRS actuarial table says was your remaining life expectancy. (If you died at age 75, that would be 13.4 years, for example.)

Either way, your daughter gets the IRA but loses decades of untaxed investment growth.

Finally, of course, there’s the worst turn of events: You assumed your daughter would get the IRA, so your will leaves the rest of your estate to someone else – say, to your trophy second wife. Even if your daughter is named in the will, she'll have to share the IRA with her stepmother. They'll also share it if there is no will. (When you die without a will, your estate is divided between your surviving spouse and children.)

And if there's a will, but it doesn't name your daughter, the missing IRA beneficiary form could result in disinheriting her. 

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.

Is My Inherited IRA Subject to EstateTax?

Q: My mom passed away in November 2010. She was a New York resident and left an IRA with two beneficiaries, myself and my sister. Is that IRA considered an asset for the purposes of New York State estate taxes? The bank has already completed transfer of the IRA distributions. I’ve rolled my portion to a new IRA to avoid tax liability, and my sister took her portion in cash. I live in another state and I’ve been advised that this IRA wouldn’t be considered a taxable asset if mom had lived here. But I need to know if it is in New York. –DM

 

A: No matter what state you live in, your estate is the value of everything you own at the time of your death -- and that means everything, from your tax-deferred retirement accounts to the loose change on your bedside table. But not all states have an estate tax; and even the ones that do have an estate tax don't tax every estate.

New York taxes estates whose value is greater than $1 million. Let's say your mother’s total estate – including her IRA – was worth $1.2 million. In that case,  a New York estate tax is due on the $200,000 excess. If her estate was worth less than $1 million, there's no New York estate tax. (In case you're wondering, in 2010 there was no federal estate tax. In 2011 and 2012, federal estate tax appies only to estates worth more than $5 million.)

Don’t confuse estate taxes with income taxes. These are two entirely different sets of taxes, with different rules, tax rates, and exemptions!

Regardless of whether your mother’s estate was taxable, you and your sister will owe income taxes on the money you take out of her IRA. If the IRA is worth $200,000, for example, and you take a $10,000 distribution, that $10,000 is added to your taxable income for the year.

Your sister took her portion in cash. If she took it in 2011, she’ll owe income taxes on the amount of her cash distribution in April 2012.

You say you transferred your share into a new IRA to avoid tax liability. As I explained in an earlier post, that new IRA must still be titled in your mother’s name to preserve its tax-deferred status. Your name can be on the account too, but as its beneficiary, not its owner.

If you’ve done this transfer correctly, you’ll only owe income taxes on your annual IRA distributions. (You must take a minimum yearly distribution from the IRA based on your life expectancy.)  But the balance of the account will continue to grow tax-deferred.

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

What Happens if You Inherit an IRA from a Trust and the Previous Owner Didn't Take His Last Annual Distribution?

Q: My father passed away in July, leaving an IRA in trust that is to be divided amongst the three children.  We intend to divide the inherited IRA (carefully), and we know we will have to take mandatory distributions starting on December 31, 2011.

My father was over the age of 71 when he died, and had not yet taken his mandatory distribution for this year (2010).  My question is:  Do we need to take a mandatory distribution from the undivided IRA this year in the amount my father would have had to take? Or do we ignore the distribution this year and start our mandatory distributions individually next year? --SK via email

A: It's never a good idea to ignore a required IRA distribution!

After you turn 70 and a half, you must take a yearly minimum distribution from your IRA, and the year of your death is no exception. If you die before taking your required minimum distribution, your heirs must take it for you.

You say your father was over 71 when he died. Assuming he turned 70 and a half in 2009, he did indeed have to take a minimum 2010 IRA distribution.

Your deadline for taking his 2010 distribution for him is this December 31. To calculate the correct amount for that distribution, use the Uniform Table for Determining Lifetime Distributions. It's at the back of IRS Publication 529, which you can download here.

That actuarial table is only for IRA owners. To calculate your own required distributions, you and your siblings should use the Single Life Expectancy Table For Inherited IRAs, which you'll find in the same publication. As you say, your deadline for taking your distributions is December 31, 2011 -- the end of the year after your father's death.

Your father left the IRA to a trust to be divided between his three children. Assuming the wording of the trust allows it, each of you can take his or her share as an Inherited IRA -- but all three of you must use the life expectancy of the oldest to determine your required distributions, says Barry C. Picker, a Brooklyn tax accountant and IRA expert. (Other IRA owners, take note: That's one of the drawbacks of leaving an IRA to a trust for several beneficiaries. They can't each base required distributions on their own life expectancies.)

To determine the correct amount, divide your share on December 31 of the previous year -- i.e., 2010 -- by the life expectancy factor on the IRS table.

If the oldest will be 49 in 2011, for example, his life expectancy factor is 35.1. 

If your share of the IRA is $25,000 on December 31 2010, your minimum annual withdrawal in 2011  would be $712.25 -- $25,000 divided by 35.1. Every year, your withdrawal will be based on the account balance at the end of the previous year; and every year, you'll reduce the original life expectancy factor by 1. (In 2012, your life expectancy factor will be 34.1; in 2013, it will be 33.1, etc.)

Of course, you can always take out more than the minimum. And as an IRA beneficiary, you don't own an early withdrawal penalty on distributions regardless of your age.

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