Carol Roth: Here are the top estate planning mistakes to avoid

Inherited IRA Rules: 6 Things All Beneficiaries Must Know

Carol Roth: Here are the top estate planning mistakes to avoid

The devastating impact of the COVID-19 pandemic has forced many families to unexpectedly settle an estate after an untimely death occurred to a loved one.

If you’ve recently inherited an individual retirement account, or IRA, you can find yourself at the tricky three-way intersection of estate planning, financial planning and tax planning. One wrong decision can lead to expensive consequences, and good luck trying to persuade the IRS to give you a do-over.

Here’s how you can avoid some costly decisions around an inherited IRA.

An inherited IRA is an IRA opened when you inherit a tax-advantaged retirement plan (including an IRA or a retirement-sponsored plan such as a 401(k)) following the death of the owner. An heir will typically have to move assets from the original owner’s account to a newly opened IRA in the heir’s name. For this reason an inherited IRA may also be called a beneficiary IRA.

Anyone can inherit an IRA, but the rules on how you must treat it differ depending on whether you’re the spouse of the original owner or someone else entirely. However, a few exceptions to this treatment do exist, as explained below.

How an inherited IRA works

Any type of IRA may be turned into an inherited IRA, including traditional and Roth IRAs, SEP IRAs and SIMPLE IRAs. Importantly, the tax treatment of the IRA remains the same from the original account to the inherited IRA. So accounts made with pre-tax dollars (as in a traditional IRA) or after-tax dollars (as in a Roth IRA) are still treated the same way in an inherited IRA.

Unfortunately, this rule is one of only a few straightforward things about inherited IRAs.

When you inherit an IRA, you have many – too many! – choices to make depending on the situation:

  • If you inherited an IRA, and you’re the spouse of the original owner, a minor child, chronically ill or disabled, or not less than 10 years younger than the original owner, you have one set of choices. But anyone else has a different set of options.
  • Whether the original account owner had to take required minimum distributions can also influence what you can and should do with the IRA.
  • Should you try to minimize taxes or maximize cash distribution from the account?

These are a few of the complex questions that an inherited IRA presents to the recipient, and the SECURE Act shook up long-standing practices, creating more confusion.

Some experts advise IRA beneficiaries to do nothing until they’ve met with a financial advisor who can explain their options.

“The worst thing to do would be to cash out the plan, put it in your account, and then go see an advisor and say, ‘Now what?’” says Natalie Choate, lawyer and author of the retirement plan guide “Life and Death Planning for Retirement Benefits.”

At that point, you’re in trouble. Before that happens, learn these six must-know tips for handling an inherited IRA.

1. Spouses get the most leeway

If someone inherits an IRA from their deceased spouse, the survivor has several choices for what to do with it:

  • Treat the IRA as if it were your own, naming yourself as the owner.
  • Treat the IRA as if it were your own by rolling it over into another account, such as another IRA or a qualified employer plan, including 403(b) plans.
  • Treat yourself as the beneficiary of the plan.

Each course of action may create additional choices that you must make.

For example, if you are the sole beneficiary and treat the IRA as your own, you may have to take required minimum distributions, depending on your age. But in the right circumstances, you may have the option of not withdrawing money.

“If you were not interested in taking money out at this time, you could let that money continue to grow in the IRA until you reach age 72,” says Frank St. Onge, an enrolled agent at Total Financial Planning, LLC in the Detroit area.

In addition, spouses “are able to roll the IRA into an account for themselves. That resets everything. Now they are able to name their own beneficiary that will succeed them and be able to deal with the IRA as if it is their own,” says Carol Tully, CPA, principal at Wolf & Co. in Boston.

The IRS provides further rules around your options, including what you can do with a Roth IRA, where the rules differ substantially from traditional IRAs.

2. Choose when to take your money

If you’ve inherited an IRA, you’ll need to take action in order to avoid running afoul of IRS rules.

Your available options as an inheritor depend on whether you’re the spouse of the original IRA owner, chronically ill or disabled, a minor child, or not less than 10 years younger than the original owner. If you’re not someone in one of these categories, you have a different set of rules.

If you’re in the former group, you have two options:

  1. You can choose to take distributions over your life expectancy, known as the “stretch option,” which leaves the funds in the IRA for as long as possible.
  2. Otherwise, you must liquidate the account within five years of the original owner’s death.

The stretch IRA is the tax equivalent of the treasure at the end of the rainbow. Hidden beneath the layers of rules and red tape is the ability to shelter funds from taxation while they potentially grow for decades.

In the second option, the beneficiary is forced to take the money the IRA over time as part of the five-year rule. For substantial accounts, that can add up to a monstrous income tax bill — unless the IRA is a Roth, in which case, taxes were paid before money went into the account.

Before 2020, these options for inherited IRAs applied to everyone. However, with the passage of the SECURE Act in late 2019, those who are not in the first category (spouses and others) have to withdraw the IRA’s full balance in 10 years. They are not subject to annual required minimum distributions, but the account must be closed out at the end of the 10-year period.

The IRS website has more information on the topic of required minimum distributions.

3. Be aware of year-of-death required distributions

Another hurdle for beneficiaries of traditional IRAs is figuring out if the benefactor had taken his or her required minimum distribution (RMD) in the year of death. If the original account owner hasn’t done this, it’s the responsibility of the beneficiary to make sure the minimum has been met.

“Let’s say your father dies Jan. 24, leaving you his IRA. He probably hadn’t gotten around to taking out his distribution yet. The beneficiary has to take it out if the original owner didn’t. If you don’t know about that or forget to do it, you’re liable for a penalty of 50 percent” of the amount not distributed, Choate says.

Not surprisingly, that can cause a problem if someone dies late in the year.

“If your father dies on Christmas Day and still hasn’t taken out the distribution, you may not even find out that you own the account until it’s already too late to take out that year’s distribution,” she says.

The last day of the calendar year is the deadline for taking that year’s RMD.

If the deceased was not yet required to take distributions, then there is no year-of-death required distribution.

4. Take the tax break coming to you

For estates subject to the estate tax, inheritors of an IRA will get an income-tax deduction for the estate taxes paid on the account. The taxable income earned (but not received by the deceased) is called “income in respect of a decedent.”

“When you take a distribution from an IRA, it’s taxable income,” says Choate. “But because that person’s estate had to pay a federal-estate tax, you get an income-tax deduction for the estate taxes that were paid on the IRA. You might have $1 million of income with a $350,000 deduction to offset against that.”

“It’s not necessary that you were the person who paid the taxes; just that someone did,” she says.

For 2021, estates worth more than $11.70 million are subject to the estate tax, up from $11.58 million in 2020.

5. Don’t ignore beneficiary forms

An ambiguous, incomplete or missing designated beneficiary form can sink an estate plan.

Many people assume they filled out the form correctly at one point.

“You ask who their beneficiary is, and they think they know. But the form hasn’t been completed, or it’s not on record with the custodian. That creates a lot of problems,” says Tully.

If there is no designated beneficiary form and the account goes to the estate, the beneficiary will be stuck with the five-year rule for distributions from the account.

The simplicity of the form can be misleading. Just a few pieces of information can direct large sums of money.

“One form that can control millions of dollars, whereas a trust could be 50 pages,” says M.D. Anderson, founder of and president of Arizona-based Financial Strategies, which specializes in inherited IRA issues. “People procrastinate, they don’t update forms and cause all kinds of legal entanglement.”

6. Improperly drafted trusts can be bad news

It is possible to list a trust as a primary beneficiary of an IRA. It is also possible that this will go horribly wrong. Done incorrectly, a trust can unwittingly limit the options of beneficiaries.

Tully says that if the provisions of the trust are not carefully drafted, some custodians won’t be able to see through the trust to determine the qualified beneficiaries, in which case the IRA’s accelerated distribution rules would come into play.

The trust needs to be drafted by a lawyer “who’s experienced with the rules for leaving IRAs to trusts,” says Choate.

Without highly specialized advice, the snarls can be difficult to untangle.

Where to turn for help

Inherited IRAs present many complications, even more so than the already-strict rules of an IRA plan. But you have several options, including some free ones, that can get you going in the right direction so that you can avoid costly mistakes.

First off, you can search for help on the IRS website. The site offers comprehensive rules on distributions from IRAs, and it’s a good first resource to answer your questions.

But what the IRS doesn’t offer is advice on which course of action you should take or what might be best for your individual situation.

So your next move is to consult with your IRA custodian, who will have more detailed info on your plan and how you can proceed.

But some IRA custodians are more versed than others in the complex rules surrounding inherited IRAs.

“Talk about it with the custodian ahead of time,” says Tully. “Plans are great, but only as far as the ability to have them properly implemented.”

The problem is that a mistake, or bad advice, made on the part of the custodian can create difficulties for the beneficiaries, and the IRS will not be sympathetic.

“The malpractice is irreversible. You cannot argue abatement of penalty and interest and taxation in an inherited IRA case. There is no justice other than a private letter ruling,” says Anderson. A private letter ruling involves handing over an IRS fee of about $6,000 to $10,000 and then waiting six months for an answer, he adds.

Finally, you have the option of hiring a lawyer or financial advisor, but be sure to select one with experience in this specific field. In the case of a financial advisor, pick a fee-only fiduciary, because they will put your interests first and you – not someone else – are paying them to do so.

This kind of advisor will help you make a decision that meets your needs and fits your specific situation. That’s especially important when the issues here are complex and it’s easy for unscrupulous advisors to do what’s in their best interest rather than yours.

If you’re getting conflicting advice or something seems wrong, don’t sign anything that could lead to something irreversible. Get a second opinion from someone with expertise specific to inherited IRAs. It really can be that complicated.

Bottom line

An inherited IRA can be a windfall, especially if you’re able to take advantage of decades of tax-advantaged compound growth.

But as you’re navigating the process you’ll want to make sure that you avoid the pitfalls, which unfortunately seem all too easy to fall into.

While relatively easy questions can ly be answered online, it could be well worth the cost to hire an advisor to help you maximize your decision and make sure it’s the best option for you.

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Carol Roth: Here are the top estate planning mistakes to avoid

Carol Roth: Here are the top estate planning mistakes to avoid

Nobody s to plan for events aging, incapacitation or death. But failing to do so can cause families burden and grief, thousands of dollars, and hundreds of hours.

It is estimated that more than 50 percent of all Americans don’t have a will, and in our Future File business, we have estimated that less than 10 percent of the U.S. population has a complete legacy and wishes planning system.

Preparing for life’s unexpected events is crucial but can often be a difficult process to navigate. Here are the top estate planning mistakes to avoid, according to industry experts:

1. Not having a will (or one that can be found) 

The leading mistake is simply not having a will in the first place.

As Kelly Dancy, an attorney at Walny Legal Group, says, “Estate planning is critically important to protect an individual, their family, and their hard-earned assets, during their lifetime, during any period of incapacity and upon their deaths. Everyone needs estate planning documents, regardless of the amount of assets that they have.”

Despite knowing this, too many people put off gathering key documents together. Tim Hewson, president of, believes that “waiting for a ‘more appropriate time’ to put together your will is a mistake. Everybody should have a will. It should be written when you are young and updated throughout your life as your circumstances change.”

In addition to having a will, it needs to be findable. The Wall Street Journal says that the biggest estate planning mistake is simply losing a will. Make sure your family has access to the documents that express your future wishes.

2. Neglecting to choose and update appropriate beneficiaries 

When you have an asset that has a beneficiary designation, that will supersede anything written in a will. Ryan Repko, a financial advisor at Ruedi Wealth Management, suggests that you review your 401(k), IRA, life insurance and any other accounts with beneficiaries after major life events.

He says, “The most grievous example [of a beneficiary issue] is when a married couple divorces, then remarries without changing the beneficiary to the new spouse. In this all-too-common and completely avoidable scenario, the ex-spouse is legally entitled to the assets, and a lengthy legal battle ensues on behalf of the new spouse and/or the children to claim the assets.”

There are financial implications to think through as well. Sheri E.

Warsh, a partner at Levenfeld Pearlstein, LLC also shares, “Without a proper beneficiary designation, income tax on retirement accounts may have to be paid sooner, which may lead to a larger than necessary income tax liability, and the designation of a beneficiary on a life insurance policy can impact whether the proceeds are subject to claims of creditors.”

Daci L. Jett, managing attorney at Daci Jett Law LLC, identifies another mistake that impacts people with minor children.

“A mistake people make is choosing a guardian for their minor children and then naming that person as beneficiary of their life insurance instead of leaving it to a trust for their child.

A named beneficiary becomes the legal owner for all purposes of the life insurance proceeds and your minor child has no recourse to get that money. Plus, it exposes the money to the beneficiary's creditors and spouse.”

Hilary Fuelleborn, an estate planning attorney with Luskus & Fuelleborn P.C., also says that not being clear about beneficiaries or ownership can create issues with the way the assets pass on to their heirs. She notes, “As parents get older, they will often put an adult child on a bank account to allow the child to pay bills for the parent. This can be a big mistake.

Upon death of the parent, that joint account automatically becomes the property of that adult child, regardless of the will that may designate all property to be divided equally amongst all children.

So, if there is $100,000 in a bank account that is joint with one child, upon the parent's death, that $100,000 belongs to that one child, regardless of whether that was the parent's intent.”

3. Overlooking the importance of powers of attorney for kids over 18 years old 

While you may think that your kids are your kids, if they are adults in the eyes of the law and something happens to them, you may be left without power – literally. Sheri Warsh advises, “If an 18-year-old becomes ill or has an accident, a doctor will not speak to a parent if a power of attorney for health care is not in place.

Similarly, unless a power of attorney for property is in place, a parent may not be able to take care of bills, make investment decisions and pay taxes without the child’s signature. This could be very difficult when a child is in college, especially if they are the country.

” It is imperative that when your child turns 18 that you get those powers of attorney put into place.

Carol Roth is the creator of the Future File legacy planning system, “recovering” investment banker and host of The Roth Effect podcast.


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