Dan Casey, for InvestorGuide.com, warns of 10 ways investors sacrifice their IRAs to the IRS.
1. Failing to understand “stretch” IRAs. With this technique, young beneficiaries can take smaller withdrawals based on their long life expectancies, allowing the IRA to continue growing after the original owner’s death. However, not all custodians honor this strategy, Casey writes.
2. Not naming a spouse as the sole beneficiary. A spouse has the unique right to roll over an IRA into his or her name, while other beneficiaries would have to begin taking withdrawals, Casey writes. Once the inherited IRA is in the spouse’s name he or she can put off taking withdrawals until they come of age.
3. Naming a trust as a beneficiary. Heirs may have to pay higher taxes than if they inherited the IRA outside the trust, according to Casey. And, the trust must qualify as a “look-through” or “see-through” trust; if the IRS decides it doesn’t meet the requirements, the heirs wouldn’t be able to stretch out distributions.
4. Procrastinating. It happens to everyone, but in this case, delay can be costly. Changes to beneficiaries should be made as soon as possible, especially if there are multiple heirs. One option, Casey notes, is to split the IRA while the owner is still alive, and name different beneficiaries for each. This way, the minimum distribution will be based on the new owner’s life expectancy, rather than the oldest of the beneficiaries.
5. Not converting to a Roth. Beneficiaries can’t convert a traditional IRA to a Roth IRA once it’s inherited, Casey warns. If the heirs are young and stand to gain from a Roth’s tax advantages, it may be better to convert the IRA now.