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Alan Haft

Avoiding a ninth-inning crash

How you can help your clients pull off a save.

June 25, 2012
by Alan Haft

So there we were, friends gathered in front of the big-screen, minutes away from celebrating the Yankees beating the Diamondbacks in the seventh game of the now ancient 2001 World Series. There was lots of excitement, pizza, soft drinks, and fireworks ready to explode. Even Lewis the bulldog was caught up in the action.

By the time the ninth inning rolled around, it was an absolute certainty the Yanks were going to win; not because they were up by a run but simply because one of the greatest closing pitchers in the history of baseball was on the mound. Mariano Rivera has more saves than any other pitcher in major league history.

With Rivera pitching, the champagne was ready to fly. The championship T-shirts and hats were being pulled from boxes, fans were going wild, and the networks hurried into the Yankee locker room to get ready for the incoming stampede.

It all sounded great, except for one thing: The celebration never took place because right there, in the bottom of the ninth, the unthinkable happened. After a near-perfect record, in the moment where it mattered most, Rivera proved that he was human and wound up blowing the game.

A client’s bottom of the ninth

When it comes to a client’s financial planning, both CPA and estate planning attorney Mark McWilliams of Boynton Beach, Fla., and I unfortunately have seen many perfect games blown in the bottom of the ninth.

What good is it to have followed all the key steps to build wealth only to blow it for the heirs? What good is it to have accumulated so much, only to see Uncle Sam enjoy far more of it than he deserves?

Yes, we’ve seen some of history’s best “closing pitchers” out there who accumulated great wealth only to blow it in the bottom of the ninth as well. They weren’t around to see their game blown, but those left behind most certainly did.

By far the most common mistake Mark and I have seen comes down to this: improperly naming beneficiaries of an individual retirement account (IRA).

It may sound like a simple disaster to avoid, but it’s amazing how many times people wind up unwillingly stepping into these problems.

Naming beneficiaries

Some planners think owners of IRAs (or other similar qualified plans) should simply throw all intended beneficiaries into the plan documents. The popular belief is that after death, these beneficiaries will be allowed to transfer their portion of the plan into their own inherited IRA, and, by doing so, they can postpone any income taxes that would otherwise be due if they took the account as a lump-sum distribution.

In many cases, this can most certainly be done, but in more cases than we wish to recall, there exists one giant Rivera moment that takes place when an entity such as a “nonperson” is included in the mix.

Keep in mind that in addition to the possible estate tax due on retirement plan balances at a client’s death, beneficiaries of these assets are generally subject to income tax on any distribution from such assets because this property constitutes income in respect of a decedent (IRD). IRD is defined as income generated (or earned) by the decedent before death that is not realized (or received) until after death.

The IRD beneficiary is subject to income taxes on such property, just as the decedent would have been if he or she were still alive and took distributions. In most cases, qualified retirement plans constitute IRD since the decedent had a right to receive such benefits at the time of death. Therefore, when retirement plan funds are withdrawn, the beneficiary is often subject to federal, state, and local income tax on the distribution, just as most account owners would have been while they were alive.

Sec. 401(a)(9)(E) states designated beneficiaries are “any individual designated as a beneficiary by the employee.” While designated individuals have the option of spreading the distribution over a longer period of time, only actual people can reap this benefit; nonperson entities such as an estate, a corporation, a charity and an LLC typically cannot. (Certain trusts can qualify as designated beneficiaries. If there are no designated beneficiaries, then the distribution of the entire amount of benefits must occur by Dec. 31 of the fifth calendar year following the participant’s date of death).

The Rivera moment

Here’s where the bottom-of-the-ninth game-ending destruction often takes place: If a nonperson (such as a charitable organization) is directly included as a beneficiary of the account, in most instances, all actual persons must liquidate the account over a five-year period instead of being able to spread the distributions over the eldest or their own life expectancies.

The solution

If the account owner named only actual persons as beneficiaries, then they all would qualify as designated beneficiaries, and, according to current regulations, the benefits could then be withdrawn over a period of time using the life expectancy of the eldest beneficiary.

But it’s critical to remember: In order for this to apply, all designated beneficiaries must be actual people.

For maximum efficiency, it is often most efficient to divide the qualified account into separate accounts whereby each account has its own designated beneficiary.

Not only does this ensure the actual people beneficiaries don’t have to cash out of the qualified plan over a five-year period, but by doing so, each beneficiary can then use his or her own life expectancy for the share of the proceeds. In instances in which ages of beneficiaries have a wide disparity, taking this additional step would be a great benefit to each person over the lifetime of his or her account.

Conclusion

No doubt, naming beneficiaries on IRA or other qualified accounts can be a tricky and complex endeavor. It’s for this reason that CPAs and estate planning attorneys specializing in this industry can be a fantastic resource for assistance. When it comes to taxes and estate planning for IRAs (and other related topics), I often turn to Mark for help. If you have questions about these subjects as well, feel free to email him.

The bottom line is, help prevent clients blowing their planning in the bottom of the ninth. After all, this isn’t the World Series we’re talking about but the livelihood of people we care about.

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Alan Haft is a retirement income planner, author of three books including the national best-seller, 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.

* For full disclosure, he is a part of Kings Point Capital  LLC, a firm that utilizes all industries which typically includes 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.