ALAN MOORE

Estate planning for an IRA’s income may be hazardous

For many individuals, naming a beneficiary on a Traditional IRA may seem like a mere formality. But negative tax consequences exist for those who, on the assumption that their assets will go to their heirs anyway, name their estate as beneficiary instead of an individual(s). When a Traditional IRA holder reaches age 70 1/2, minimum distributions become mandatory and must begin by April 1st of the following year. These distributions are based on the life expectancy of the holder and the named beneficiary if a joint life calculation is selected. (A joint life calculation is generally viewed as more desirable because the mandatory payments are lower.) Once the distribution schedule has been established it cannot be changed while the Traditional IRA holder is living except under certain circumstances it may be shortened. If the named beneficiary is the estate, the distributions cannot be based on a joint life (the estate does not have a life expectancy). Therefore, the required distributions will be larger because the life expectancy can only be based on that of the single Traditional IRA holder. For those clients who do not need Traditional IRA distributions as a source of income, having to take larger distributions than absolutely necessary can be frustrating. When a Traditional IRA holder dies, the distribution of assets is dependent on whether or not the Required Minimum Distributions (RMDs) have begun. If the Traditional IRA holder had not yet reached age 70 1/2 and the RMDs have not begun, the estate is required to take full distribution by December 31st of the fifth year following the date of death. If an individual had been named as beneficiary, he/she would have the option to spread the distributions out over his/her own life expectancy; if the beneficiary were a spouse, the spouse could elect to roll the assets into his/her own Traditional IRA. (The spouse is the only beneficiary who can make this election.) Even though the beneficiaries of the estate will receive their due in the end, the difference between taking distributions within five years or enjoying the benefits of tax-deferred growth through their own life expectancy could be significant. If a Traditional IRA holder dies after the RMDs have begun, the way in which those distributions have been calculated becomes crucial. If the distribution has been recalculated each year, the estate beneficiary must take full distribution by December 31st of the year following the date of death. This is because re-calculation requires that the life expectancy be “re-calculated” from the IRS Life Tables each year, and when the Traditional IRA holder dies, his/her life expectancy drops to zero. Therefore, the entire balance must be distributed within the year. If the Traditional IRA holder had not been re-calculating and had been using the “elapsed years method” (also referred to as “term certain method”), the estate is permitted to continue using the same method or distribute at least as rapidly under another method. The taxation rules applicable to estates and distributions are exceedingly complex. If you have named your estate as beneficiary, the beneficiary designation can be changed up until the point at which RMDs begin. There may, however, be some very good reasons why a tax attorney may advise you to leave an estate beneficiary intact. Therefore, it’s important to make certain that you are taking advice from a qualified expert in the estate planning area. ALAN S. MOORE is a Financial Advisor of Legg Mason Wood Walker, Inc., a diversified securities brokerage and financial services firm that is a member of the New York Stock Exchange, Inc. and SIPC.