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Alan Haft

Maximizing IRA for Heirs

How separating your client’s IRA can be advantageous.

November 21, 2011
by Alan Haft

I don’t know about you, but trying to figure out the best way to maximize the value of an individual retirement account (IRA) for beneficiaries is typically not the most exciting part of my day. But paying careful attention to the manner in which it’s passed really does deserve some important attention.

After all, in my experience, I’ve seen more loss caused by the structure in which an IRA is passed to heirs as opposed to the destruction something such as market losses can cause.

Although this one subject has been the focus of countless books, I hope this short column’s few and brief ideas can be of some help.

Split It

If a client has several beneficiaries of their IRA, chances are the transfer of each person’s portion should be treated differently. In these cases, separating the IRA into several different accounts is often quite advantageous and the most efficient method of transferring the asset. 

The primary reason for considering a split is when there’s a significant age difference among beneficiaries. In these cases, separating the IRA can enable younger beneficiaries to maximize their potential for tax-deferred growth and asset accumulation.

When a split is done prior to death, upon the IRA holder’s demise, each beneficiary would have the absolute ability to calculate their own required minimum distributions (RMD) based on their life expectancy. Doing so prevents all beneficiaries from not only inheriting the IRA, but also inheriting the life expectancy of the eldest beneficiary, which would most often be the case if the asset was passed as a single account; the manner in which most IRAs are handed over.

Separating the account among several beneficiaries allows younger beneficiaries to take smaller RMDs and therefore reduce their taxable income as well as allow the asset to grow that much more in a tax-deferred structure.

To accomplish the split, all your client needs to do is simply separate the IRA in any way they choose — equally, or leaving more to some beneficiaries as opposed to others. For example, if someone with three beneficiaries has a $100,000 IRA, he could separate this into three distinct IRAs (one for each beneficiary) with values of, for example, $40,000, $40,000 and $20,000 to the child who always forgets to send birthday cards.

Investment Choices

Another important benefit of separating the IRA is that the owner can also select different investments for each account. For example, your client can choose more aggressive stock funds for younger beneficiaries who can afford a higher level of risk and something such as more conservative bond funds for older beneficiaries who may need income from the account when inherited.

I believe this is a very important benefit frequently overlooked. Often (and hopefully), the person passing the IRA has lived a long life and is of an older age. If allocated according to typical financial planning standards, the older a person is, the more likely the account is going to be invested quite conservatively.

If, however, the client separates the IRA, he can then allocate the portfolio much more freely according to the person who’s inheriting it and therefore plan the investments accordingly.

It should be noted that if the IRA owner is indeed older and has separate the accounts, keep in mind that the Internal Revenue Service (IRS) doesn’t care from which account the RMD comes. As long as the total RMD is calculated factoring in all accounts, the appropriate RMD can be withdrawn from any account and this flexibility provides for the most efficient distribution at the time of death. 

Especially over these few years where various investments have performed quite differently due to the erratic market, this RMD flexibility has proved to be enormously beneficial to some of my clients who have followed this simple yet highly effective strategy.

A Word About RMDs

Whether clients have one IRA account or several, it’s important to think about how their beneficiary designation will affect their RMDs.

A client’s RMD depends on the method of calculation, which can be based on one of three factors:

  1. The single life expectancy of the IRA holder,
  2. The joint life expectancy of the IRA holder and their spouse beneficiary and
  3. The joint life expectancy of the IRA holder and their non-spouse beneficiary.

The single life expectancy method generally results in the largest distributions and the highest potential taxable income, so it’s typically most appropriate for IRA holders that plan or want to withdraw most of their IRA during retirement.

The joint life expectancy with a spouse beneficiary can potentially reduce the IRA holder’s required minimum distribution and current taxable income as well as increase the potential for tax-deferred growth. In addition, upon the IRA holder’s death, the spouse beneficiary generally has more distribution timing options.

Even better might be the joint life expectancy with a non-spouse beneficiary method. In such cases, the beneficiary may be a child or grandchild, and this may be the most appropriate for IRA owners who wish to maximize tax-deferred growth and leave the longest possible legacy for heirs.

Be Sure to Get Professional Advice

Structuring the most efficient IRA transfer to heirs is a complex subject that often needs to factor in many different elements. For example, special rules apply to non-spouse beneficiaries when determining the life expectancy factors. Before making any decisions about IRA accounts and beneficiaries, clients should always consult you or another qualified tax and/or financial adviser who understands the complex rules surrounding this subject.

Simple tips, such as those cited above, can make a dramatic difference in your client’s nest egg, especially when heirs inherit it.

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Alan Haft is an investment advisor, author of three books including the national bestseller, You Can Never Be Too Rich and makes frequent appearances in national print, television and radio media such as The Wall Street Journal, Money magazine, CNBC, BusinessWeek and many others. The amounts represented in this article should all be considered hypothetical, for example only and the facts should always be checked with a qualified tax professional before any actions are ever taken.

For full disclosure, Haft is a part of a firm that utilizes all industries which typically includes us receiving percentage based fees for brokerage services as well as commissions when implementing insurance based plans. Haft does not work for any particular financial company or industry nor should this column be construed as an endorsement or condemnation for any particular product. Readers should note that all views and vendor recommendations as expressed in this article are solely the author’s and do not necessarily reflect the views of the AICPA CPA Insider™ or the AICPA.

* This article is not intended to provide financial planning, tax or legal advice and should not be relied upon as such. Any specific tax or legal questions concerning the matters described in this article should be discussed with your tax or legal advisor.

** The AICPA’s PFP Section provides information, tools, advocacy and guidance to CPAs who specialize in providing tax, retirement, estate, risk management and investment advice to individuals and their closely held entities. All members of the AICPA are eligible to join the PFP section. For CPAs who want to demonstrate their expertise in this subject matter, apply to become a PFS Credential holder.  For more topics such as this, join us at the 2012 Advanced PFP Conference on January 16-18, 2012 in Las Vegas.