Over 4,000 people reach the age of mandatory IRA distributions
every day. Some have $100,000 to $1 million+ in their plans. Do
you ignore this market?
When IRS "simplified" the IRA distribution rules in January 2001,
many advisors mistakenly believed that there was no longer an
opportunity to gain IRA assets through IRA distribution planning
services. The new rules have in fact not made planning simpler,
they have simply replaced one set of planning opportunities with
another. In this article, you will learn the expensive mistakes
that many IRA owners encounter and how you can use superior
knowledge to attract IRA and qualified plan assets.
Mistake #1
Every IRA owner can name a beneficiary and "stretch" the IRA for
maximum tax deferral over the next generation.
Informed IRA owners believe that the following will occur with
any retirement assets they do not consume. Say they leave
$500,000 of retirement assets. They believe junior will make
small withdrawals each year (required by IRS) and at 6%, the
account with a 42-year-old beneficiary, will generate $2.5
million during junior's lifetime (distributions plus ending
balance at life expectancy). This sounds great but it may never
happen.
There are at least 2 ways that the stretch IRA can fail. The
first way is because of a custodian with rules that do not permit
lifetime payments. This is particularly common in qualified plans
where the rule may be that "all distributions to beneficiaries
are to be completed within 5 years." Since no one ever reads that
fine print for their qualified plan, they have no idea that a
fast distribution will be forced to non-spouse beneficiaries.
The other problem is the beneficiary. Just because mom and dad
have the good sense to understand tax deferral does not mean that
junior will comply with this wisdom. The minute junior finds our
that he can close the IRA, take all the money and buy a Ferrari
and Lamborghini at the same time, he does so, pays a fortune in
taxes and blows the money to have fun.
The way to control this is to have your clients leave their
retirement assets in an IRA trust. In a trust, mom and dad can
control how the heir gets paid.
Mistake #2
I am leaving my IRA to my wife. I only have one son and he can do
with the IRA what he wants when we are both gone. My situation is
simple. When most people select beneficiaries for their IRAs,
they select their spouse or their children. As simple as this
seems, it can create problems. Consider these two scenarios.
When a plan owner leaves an IRA account to the spouse, it
inflates the spousal assets. And when the spouse later dies with
an estate exceeding $1 million (the estate exemptions limit in
2003), they pay estate tax. By leaving the IRA to the spouse, the
deceased spouse has created unnecessary estate taxes by making
the survivor's estate larger.
So instead, they leave the IRA to the son. But as indicated
before, this leaves the son total control over the asset. He may
withdraw the funds immediately and decide to buy a mansion
jointly with his spouse (who was despised by mom and dad). To
complete your client's misery, let's say that the following week,
the daughter-in-law files for divorce and gets to keep the
mansion in the settlement. Mom and dad just gave the despicable
daughter-in-law a mansion with their IRA money. Even in death
they have money problems.
To avoid the above two scenarios, they decide to leave the IRA to
the "estate." Many attorneys advise that you never leave a
retirement plan to your estate. Because at death, the IRS
requires the account to be rapidly distributed rather than enjoy
the potential stretch over the lifetimes of beneficiaries.
Additionally, the IRA will now be a probate asset and subject to
claims of creditors. So what do rich people do to avoid the three
gloomy scenarios above? They leave their IRA in a trust and
appoint a trustee like an accountant, financial advisor,
attorney, etc., a person that has good common sense and tax
knowledge. Within the boundaries of mom's and dad's wishes and
IRS-required minimum distributions, the trustee will determine
who among the beneficiaries will get the IRA and how much they
get. The trustee will determine how quickly this money gets
distributed over and above the annual minimum amount of required
IRS distributions. Mom and dad can even give very detailed
instructions. For example, they could dictate no distributions
for purchases of homes with the despicable spouse. Or if the
money is to be used for education they may stipulate that up to
$15,000 a year can be distributed, or to start a business up to
$25,000 can be distributed, and they can go on and on with such
instructions.
Your clients don't realize that the above problems can arise and
they also don't know the solution. Use this knowledge to be the
valuable advisor in yet one more instance.
Mistake #3
The IRA owners has checked with the custodian and yes, they do
allow lifetime distributions to non-spouse beneficiaries.
Additionally, their two unmarried sons understand tax deferral
and there is no need for a trust. Everything is okay.
Many plan owners don't consider what happens if their beneficiary
pre-deceases them.
Let's say your client has two sons, Jack and Tom. Your client
names them as primary beneficiaries for the IRA by completing an
"IRA Beneficiary Designation Form" at the bank or securities
firm.
As shown above, Jack and Tom each have a son. Jack's son is Bob.
Tom's son is Dan. So your client writes the grandson's names on
the line of the beneficiary designation form that says "secondary
beneficiaries."
If Jack dies before his parents who own the plan assets, they
probably think Jack's share goes to his son, Bob. Wrong.
It goes to Tom, because on the beneficiary designation form,
there is no place to specify how the primary beneficiaries and
secondary beneficiaries are related. There is no place for you to
explain your intentions or write "per stirpes" to clarify
intentions with respect to those beneficiaries. Those beneficiary
designation forms with the bank or the securities firm are not
sufficiently detailed to carry out the probable wishes of your
clients.
At minimum, your client should replace those forms with their own
forms, called an "IRA Asset Will." This can be inexpensively
prepared by any attorney. And if the custodian won't accept it,
move your client's account to another custodian.
Mistake #4
Failing to use IRA funds for charitable intent.
If your clients wants to leave even $1 to charity, do it from the
IRA money. Clients can specify one or more charities to receive
portions of the IRA and the heirs will thank you. When taxpayers
leave heirs a dollar of IRA funds, the heirs will pay, for
example, 35 cents to tax and have 65 cents left to spend. If the
estate is over $1 million, heirs will also pay estate tax on this
money and may have only 30 cents left from each dollar. However,
when mom and dad leave heirs a dollar that is non-retirement
money, heirs can spend it with no income tax. Therefore, heirs
would much rather have "regular" money and not retirement money.
Mistake #5
Failure to realize that a bear market can help their retirement
account.
Most people have heard of the Roth IRA but few seniors have
converted their regular IRAs. And that's understandable, as the
tax on the conversion becomes immediately due. However, now may
be the time to give this option your clients' full attention.
The one good aspect of a bear stock market is that when the IRA
balance is down, the owner can convert to a Roth IRA, pay tax on
a reduced value, and future distributions are tax free. (For the
first 5 years after conversion they may withdraw principal tax
free, but earning withdrawals would be subject to tax. If under
age 59½, all withdrawals are also subject to penalty). Not
everyone can take advantage of the Roth conversion, as the
adjusted gross income must be under $100,000. This may be an
opportunity for you to help clients "engineer" when they receive
income. For example, those people with a business or income in
their control may be able to defer income, drop their income for
one year, and make the Roth conversion. This conversion is best
for people who prefer to have growth-oriented investments in
their IRA and plan to take advantage of much of their balance
during their lifetime.
There are additional benefits since distributions from a Roth IRA
are tax free (unlike the minimum distributions from a regular
IRA). Some clients may even pay less tax on your social security.
Income because of the tax free nature of Roth distributions.
Since the tax on social security income is calculated on total
income (minus distributions from a Roth IRA), some clients may
experience additional tax savings from a Roth conversion.
Additionally, for those who are married, it is common that the
household income remains the same when one spouse dies. This
often pushes the single spouse into a higher tax bracket (because
single people are taxed more heavily than married people on the
same income). By having a Roth IRA, the tax-free distributions
can help a surviving spouse minimize their tax bracket. Would the
Roth IRA benefit your clients? During a depressed market is the
time to give this a hard look.
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