Individuals and their financial advisers spend the better part of 30 years worrying about how to get money into individual retirement accounts.
They should at least spend a little time worrying about how they and their heirs will get money out.
That's because the tax code is filled with little-known and little-understood regulations that, along with estate taxes, can create a "double tax syndrome."
If steps aren't taken to avoid the land mines, an individual's heirs can expect to lose more than 70 percent of the IRA assets.
The problem is a fairly new one. Only recently have IRA accounts been large enough to trigger such heavy penalties. Accounts have been fattened by stellar stock market returns during the past decade and the increasing volume of 401(k) "rollovers" into IRA accounts.
"Ten years ago, a person's largest asset was the home; today the largest asset is their retirement account," said Buzz Hankinson, certified financial planner with Hankinson Retirement and Investment Specialists.
Estates with large IRA accounts, usually $1 million or more, are most susceptible. These days, with employee stock options available to even rank-and-file employees, modest wage-earners can achieve such nest eggs.
"A million dollars isn't what it used to be," said Steve Marbert, a financial planner with Richard Young Associates.
IRAs are essentially tax sheltered accounts, so the key to protecting the assets within lies in extending the life of the IRA as long as possible. Planning should begin long before an individual turns 70, the year they are required to begin tapping the account. These income-taxable withdrawals are referred to as "distributions."
Professional help is usually required to develop a strategy, which can range from establishing bypass trusts to creating a "multi-generational IRA" that allows the assets to continue growing tax deferred as distributions are passed to children and grandchildren over time.
"We ask folks all the time, `Do you think it would be appropriate to draw out $800,000 lump sum?' Heck no, they say. Then we ask, `Well why do you think your children should?"' Mr. Hankinson said.
Another option to minimize taxes is to convert the IRA into a Roth IRA, a newer-type of account where withdrawals do not carry tax penalties because contributions made to an IRA must be post-tax earnings.
Conversion is not an option for everyone because doing so can result in an up-front tax-bite.
"Some people just can't do it," Mr. Marbert said. "Emotionally, it can be a very difficult thing to do."
In mid-January the Internal Revenue Service adopted new rules designed to simplify IRA distributions and make it easier for individuals to prolong the life of the IRA by allowing them to name beneficiaries well after age 70.
Here's the catch: IRA plan custodians, the company that administers your account, is required to report an individual's required minimum distribution to the IRS.
Mr. Hankinson said the IRS created the paper trail to improve compliance, ensuring the trillions of dollars coming out of Baby Boomer retirement plans during the next 10 to 20 years is taxed accordingly.
Prior to the new rules, there was no way to know if an individual took their required IRA distribution.
Reach Damon Cline at (706) 823-3486 or firstname.lastname@example.org.
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