ABC Taxes, Tips & Tools

Who will get the money in your IRAs if some­thing hap­pens to you?  Do you think you know?  You might be sur­prised to learn that Uncle Sugar, in his tax man guise, could take 35 – 100 % if a multi­gen­er­a­tional IRA (also called a Stretch IRA) strat­egy is not adopted.  Remem­ber when you set up that tax-deferred retire­ment account, you made the tax man your silent part­ner, agree­ing to pay him the taxes sooner or later.  Unless you do things in a spe­cific way, the US gov­ern­ment may be the pri­mary ben­e­fi­ciary of your IRA if you die, but it doesn’t have to be that way. 

I know many of you are focused on build­ing your nest egg, or if you are retired, you are wor­ried about whether your retire­ment funds will last you until you shuf­fle off this mor­tal coil.  The first thing I want to you to under­stand is that this strat­egy does NOT take any money from you while you are alive or your spouse if (s) he out­lives you.  This strat­egy only affects what hap­pens if you die and leave any IRA to your ben­e­fi­cia­ries.  This strat­egy costs you nothing. 

With­out it though, your ben­e­fi­cia­ries could get hit with a huge tax bill that could lit­er­ally take it all and leave your heirs with noth­ing.   Hey, nobody plans to die, but if you do sud­denly van­ish from the earth, who do you want get­ting the money you worked your whole life to save?  Your heirs or the fed­eral gov­ern­ment? In a real world exam­ple a Cal­i­for­nia teacher worked her whole life to amass $1.2 Mil­lion dol­lars and died 6 months after she retired; because her ben­e­fi­cia­ries were improp­erly des­ig­nated in the cus­to­di­ans paperwork, they received a total of $300,000 — the other $900,000 went pay taxes to the state and fed­eral gov­ern­ment.  Had they been able to keep the IRA in its tax-advantaged wrap­per they could have eas­ily received $4 mil­lion dol­lars in life­time distributions. 

I speak of IRAs but I am refer­ring to all pen­sion plans to some extent.  The very first thing you must do is go check with your 401(k), 403(b), IRA, or other pen­sion plan cus­to­dian and see who the ben­e­fi­cia­ries are.  You may get sur­prised what you find out, espe­cially if you com­pleted the paper­work 15 years ago and for­got about it.  Merg­ers, acqui­si­tions, bank clo­sures, com­puter data migra­tions etc. hap­pen and there is a cer­tain error rate asso­ci­ated with these procedures-even if you did des­ig­nate some­one, that file could be lost.  You may have had major life events that you did not ade­quately deal with as well.  You should check at least once a year to see who is listed as your ben­e­fi­cia­ries. You should make changes ASAP, if you have a change in life such as divorce, death, or just decide you don’t like some­one anymore-if not you could be the sub­ject of the next hor­ror story. 

Do not assume divorce decrees, prenup­tial agree­ments or other legal doc­u­ments will take the place of this designation-they won’t.  These other doc­u­ments will not work as they are gen­er­ally writ­ten under state laws; fed­eral law trumps state law. Don’t think so? Read hor­ror sto­ries a lit­tle bit fur­ther on. 

Multi­gen­er­a­tional IRAs (Stretch IRAs), a tax strat­egy for your heirs

1. Name your ben­e­fi­cia­ries and des­ig­nate the per­cent­age they are to receive

This whole strat­egy revolves around nam­ing your ben­e­fi­cia­ries and keep­ing that des­ig­na­tion cur­rent.  The key to ben­e­fi­ciary des­ig­na­tion is that ben­e­fi­ciary has to be named, and you have to spec­ify the amount each ben­e­fi­ciary receives.  You can say,  “John Doe 33%, Jane Doe 33% and XYZ Char­ity 34%”, but not “John Doe, Jane Doe and XYZ Char­ity equally” as the amounts are not des­ig­nated, nor “My chil­dren, and XYZ Char­ity split equally” as nei­ther the names of the chil­dren or the amounts are des­ig­nated.  If you do not name your ben­e­fi­cia­ries and des­ig­nate the amount they are to receive, your heirs will not be able to retain the IRA tax advan­taged wrap­per & will have to pay all the taxes on the IRA at once; this error can cost your ben­e­fi­cia­ries most or all of their inher­i­tance.  But if you do some dis­tri­b­u­tion plan­ning you can pass the IRA to your heirs with its wealth intact.  Your heirs will be required to take dis­tri­b­u­tions based on their life expectancy, while the remain­der can grow with its tax-advantaged status. 

2. Do a cus­to­dian review

Your IRA cus­to­dian is the bro­ker­age, bank or other entity that holds your IRA.  You need to make sure your cus­to­dian will allow the multi­gen­er­a­tional IRA strat­egy.  “What?” You are say­ing, “You mean my cus­to­dian doesn’t have to allow this tax strat­egy?” Nope, when you signed all that paper­work when you set up your plan, you pretty much gave them con­trol over it. You’d prob­a­bly be sur­prised what you have agreed to.  There is at least one pop­u­lar cus­to­dian that does not allow trustee to trustee trans­fers of non spousal IRAs – mean­ing if you named your grand­kids as ben­e­fi­cia­ries, they have to stay with with that cus­to­dian in order to main­tain the IRA sta­tus — the cus­to­dian holds your IRA hostage.  Another cus­to­dian dis­in­her­ited a bunch of peo­ple when they went to only allow­ing a sin­gle named ben­e­fi­ciary; at the time the cus­to­dian made the change they selected the old­est named beneficiary-they didn’t tell any­one, they just did it.  But remem­ber, you have the power to vote with your feet.  If your cus­to­dian doesn’t allow you to set up your multi­gen­er­a­tional IRA strat­egy, then you can do a trustee to trustee trans­fer to a cus­to­dian who does. 

If your cus­to­dian allows the multi­gen­er­a­tional IRA strat­egy, then the ben­e­fi­cia­ries, sec­ondary ben­e­fi­cia­ries and con­tin­gent ben­e­fi­cia­ries must be named and have des­ig­nated amounts (per­cent­ages); this state­ment is true even in the case of your spouse.  Name your ben­e­fi­cia­ries and the amounts they should receive, and keep the infor­ma­tion cur­rent.  In the case where an IRA has named des­ig­nated ben­e­fi­cia­ries, the dis­tri­b­u­tion usu­ally defaults to the multi­gen­er­a­tional strat­egy.   And remem­ber check back reg­u­larly to see that your strat­egy is being main­tained, as cus­to­di­ans can change the rules…

It bears repeat­ing, the ben­e­fi­cia­ries must be named and have des­ig­nated per­cent­ages of the IRA they may inherit; the cus­to­dian must have this infor­ma­tion & per­mit the multi­gen­er­a­tional strat­egy. 

3. Spe­cial Paperwork

Third you need to sign a tes­ta­ment and give it to your ben­e­fi­ciary for their tax records (in the event they do inherit the IRA), basi­cally stat­ing it is given uncon­di­tion­ally to them-they must be allowed to do fool­ish things like take all the money at once and pay exor­bi­tant taxes if they want to, but if you are kindly dis­posed you cer­tainly can dis­cuss the multi­gen­er­a­tional IRA strat­egy with them before you die or have the execu­tor of your estate go over it with them.  But you can­not require a ben­e­fi­ciary adopt the multi­gen­er­a­tional IRA strat­egy etc.; the IRA has to be handed over unconditionally. 

4. Other Com­ments

Another point, you have to name a real liv­ing per­son as a ben­e­fi­ciary.  Dead peo­ple and trusts don’t work.  The whole idea is to keep the IRA alive at least as long as the ben­e­fi­cia­ries’ life expectan­cies.  You can buy insur­ance to help your heirs pay the taxes on the IRA too, but that topic is beyond the scope of this discussion. 

Hor­ror stories

Source: NY Post arti­cle, Pen­sion Pickle, by Zach Haber­man Jan­u­ary 31, 2005.  A wid­ower lost his wife’s pen­sion worth nearly $1 mil­lion dol­lars when it was awarded to her sis­ter.  Anne Fried­man com­pleted a ben­e­fi­ciary form 4 years before she met & mar­ried Bruce; they were mar­ried 20 years but Anne never changed the ben­e­fi­cia­ries on her pen­sion plan. She named her mother and uncle (both now deceased) as pri­mary ben­e­fi­cia­ries, with her sis­ter as the sec­ondary ben­e­fi­ciary. The Anne was a teacher in the NY pub­lic schools which is exempted from Employee Retire­ment Income Secu­rity Act’s (ERISA) pro­vi­sion that requires a spouse to sign a doc­u­ment specif­i­cally opting-out of inher­it­ing a pen­sion.  The NY Courts ruled that they could not inquire to Anne’s inten­sions; they had to go with the paper­work they had. 

Source:  On the Docket, US Supreme Court News, Kennedy v. DuPont Plan Admin­is­tra­tor, Jan­u­ary 26, 2009.  A William Kennedy divorced his wife, Liv-as part of the divorce decree the wife gave up claim to his pen­sion plan, but he never changed the ben­e­fi­ciary, even though he intended for his daugh­ter, Keri, to receive his estate.  When he died, the daugh­ter pro­duced the divorce decree but the Plan Admin­is­tra­tor refuse to pay up as her father never changed the ben­e­fi­ciary infor­ma­tion and the ex-wife never signed a waiver opt­ing out of his pen­sion plan as would be required under ERISA.  Since the ex-wife was dead by then, her new hus­band, the man she left William for wound up receiv­ing the pension.

Source: Plan Spon­sor Mag­a­zine, Greenebaum Doll & McDon­ald, PLLC v. Deb­bie D. San­dler, Shan­non San­dler et al. and Chris Mein­har, Feb­ru­ary, 2008,. Deb­bie and David San­dler got mar­ried.  Before they got mar­ried, Deb­bie signed a prenup­tial agree­ment releas­ing claim to his pen­sion plan, which he intended for his chil­dren.  The mar­riage did not work out; they were get­ting a divorce when he com­mit­ted sui­cide.  His chil­dren attempted to claim his pen­sion, but Deb­bie said, “Not so fast” and made her own claim.  The court said that ERISA trumped the prenup­tial agree­ment.  David never asked Deb­bie to sign the waiver, even though the prenup­tial agree­ment would have required her to do so had he ever pre­sented one, so she got every­thing and his kids nothing. 

I hope these hor­ror sto­ries moti­vate you into do some “dis­tri­b­u­tion plan­ning” on your retire­ment accounts. Des­ig­nate named ben­e­fi­cia­ries and keep them current-this will save your heirs a lot of taxes. Get a spousal waiver if you want to leave your pen­sion to some­one other than your spouse, if required to do so under ERISA. If you have a major life event, make chang­ing your ben­e­fi­cia­ries a priority. 

As always, small busi­ness ser­vices and tax­a­tion are our busi­ness.  If you need help Please give Art & Busi­ness Con­sult­ing a call.  We would love to engage you as a client.

The usual dis­claimers: Although ABC has made every effort to insure the accu­racy of Taxes, Tips and Tools, mis­in­for­ma­tion, dis­in­for­ma­tion, changes, mis­takes, typos and hack­ers hap­pen, there­fore Art & Busi­ness Con­sult­ing LLC takes no respon­si­bil­ity for any action taken or results based on the infor­ma­tion sup­plied here in. The con­tent of this blog gen­er­ally applies to busi­ness and indi­vid­ual tax­a­tion in the United States of Amer­ica.  Inter­nal Rev­enue Ser­vice Cir­cu­lar 230 Dis­clo­sure:  As pro­vided for in Trea­sury reg­u­la­tions, advice (if any) relat­ing to fed­eral taxes that is con­tained in this com­mu­ni­ca­tion (includ­ing attach­ments) is not intended or writ­ten to be used, and can­not be used for the pur­pose of (1) avoid­ing penal­ties under the Inter­nal Rev­enue Code or (2) pro­mot­ing, mar­ket­ing or rec­om­mend­ing to another party any plan or arrange­ment address herein.  Art & Busi­ness Con­sult­ing LLC cur­rently does not have a cer­ti­fied pub­lic accoun­tant, human resource spe­cial­ist, or an attor­ney on staff; this infor­ma­tion is purely for edu­ca­tional pur­poses and not to be con­strued as legal or finan­cial advice. Art & Busi­ness Con­sult­ing LLC and its employ­ees, mem­bers and asso­ciates are not engage to prac­tice law; you always should dis­cuss legal mat­ters with your attor­ney before talk­ing to any­one else.

Tags: beneficiary, designate beneficiary, distribution planning, exit strategy, inheritance tax, IRA, IRA custodian, IRA horror stories, multigenerational IRA, stretch IRA, testament

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