Yahoo! Finance has a great article on costly mistakes that can hamper your retirement-savings withdrawals. Here's the situation:
" 'People are not aware of the importance of planning for eventual distributions,' says Ed Slott, a certified public accountant and author of Parlay Your IRA into a Family Fortune."
"Retirement-plan distribution mistakes can result in costly tax bites for retirement-plan owners or beneficiaries. And there are a lot of traps for the unwary."
According to Yahoo!, here are "what experts say are the top retirement-plan distribution traps and how to avoid them, or at least mitigate them":
1. Failing to name a beneficiary for your plan or IRA -- Slott says not naming a beneficiary for your IRA or company plan is, by far, the worst mistake since it directly affects the long-term payout of your IRA after death and determines who will receive it. If you don't name a beneficiary, the distributions and tax bite could be larger than need be.
"If you do not have a named beneficiary, then whoever receives your IRA will probably have to go through probate and will not be able to take advantage of the stretch IRA (which can be distributed over the life of the beneficiary)," he says. "Only a named beneficiary or what's called a designated beneficiary can do that."
What's worse, if you don't name a beneficiary, your IRA may go to someone you did not want it to.
2. Taking the right minimum required distribution -- If ever there was a trap awaiting poor, unsuspecting seniors it's the rules governing MRDs, which dictate when benefits must be paid out of retirement plans. "Understanding these rules is key to successful tax planning for retirement plans," writes Natalie Choate in her book "Life and Death Planning for Retirement Benefits."
Marvin Rotenberg, director of retirement services at Bank of America in Boston, says many seniors get tripped up by MRD rules, especially during the first couple years of having to take a distribution. In some cases, they fail to take a MRD, saying that they don't need the money. In other cases, they use the wrong year-end account balance and the wrong life-expectancy factor from the Uniform Life Table to calculate their MRD.
What's the big deal if you use the wrong life-expectancy factor or fail to take a MRD? Uncle Sam will impose a 50% penalty on the amount you should have taken but didn't. For small accounts, the penalty will be a nuisance. For big IRA accounts, it represents a lot of money that would have been better spent on vacations and the like. "You don't want your distribution subject to a penalty," says Rotenberg.
How to avoid this trap? Check and double check what life expectancy factor and year-end account balance you should use long before turning age 701/2.
Also, Rotenberg says seniors ought to factor in potential state income-tax consequences of taking two MRDs in one year. In New York, for instance, retirees don't have to pay any state income tax on the first $20,000 of income from a retirement account. But if a person takes two MRDs in one year, which is allowed only in the first two years, they may find themselves being taxed unnecessarily on the second MRD.
3. Get to know NUAs and other tax breaks -- Plenty of retirement investors who own company stock in their retirement plan pay more in taxes than they need to because they are unfamiliar with the net unrealized appreciation rules, says Barry Picker, a certified public accountant and author of "Barry Picker's Guide to Retirement Distribution Planning."
In essence, those who retire or leave a company and who own company stock in a retirement plan can either roll the stock over into an IRA and eventually pay taxes at ordinary income rates after selling that stock and withdrawing those funds. Or they can distribute the company stock into a taxable account, paying a tax on the cost basis of the stock and then paying -- provided it's been held long enough -- the lower long-term capital-gains rate when they ultimately sell the stock.
4. Getting no respect -- Many IRA beneficiaries don't realize that IRAs are considered "Income with Respect to a Decedent" by the IRS, says Bruce Harrington, vice president and product manager of retirement plans at MFS. At death, he says, IRAs are included in the IRA owner's estate, creating -- if applicable -- an estate-tax liability as well as an income-tax liability for beneficiaries.
"The 'IRD Rule' allows beneficiaries to take an income-tax deduction for any estate taxes paid on an IRA's assets, thus limiting double taxation," he says.
5. Ignorance is expensive -- Not knowing that a nonspouse beneficiary cannot do a rollover and not knowing how to set up an inherited IRA can be expensive mistakes, says Slott. "Only a spouse can do a rollover," he says. "But most inherited IRAs are wiped out because of this error." Advisers, and especially attorney's handling the estate of an IRA owner, rarely know this rule and often they advise the beneficiary to put the IRA into his own IRA. "That cannot be done," says Slott. "That is a rollover and is not permitted. This will trigger immediate taxation of the entire inherited IRA and the stretch option will be lost forever, not to mention the big tax bill the beneficiaries will receive."
He also says the inherited IRA must be set up correctly. The deceased IRA owner's name must remain on the account. "Not knowing how to set up an inherited IRA is a costly error since it usually ends the account and triggers immediate taxation," says Slott.
Yahoo! concludes that for this issue the bottom line is: "Retirement account owners and their beneficiaries should work only with qualified and competent advisers."
Update: Linking to the Beltway Traffic Jam.
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