Dangers of Inherited IRAs, Part 2

Last week, we tackled some pretty major questions about protecting your retirement accounts as part of your estate, given the limited protections offered by traditional wills.  You can read that article here.  This week, we’re picking up where we left off and answering four more questions. 


4. Why does a “stretch” make more sense than a lump sum distribution?

A lump sum distribution of an IRA will trigger all of the income taxes to be paid immediately. For instance, on a $200,000 IRA at a 25% tax rate, the beneficiary will be left with $150,000. Even worse, the remaining funds are no longer tax-deferred, but rather subject to ordinary income and capital gains taxes. In other words, that lump sum may be whittled down rather quickly and your biggest beneficiary would be… good ol’ Uncle Sam.

By contrast, a $200,000 IRA, protected and “stretched” over a beneficiary’s lifetime, may be produce more than $1.5 million over a beneficiary’s lifetime, depending on their age and how the IRA is invested.  Why is this the case? A younger beneficiary can let the funds sit in the IRA tax-deferred account for a longer time period, meaning Uncle Sam can’t eat away the principal with taxes.  


5. Can my beneficiary simply roll-over my IRA into their own IRA?

No.  The only person that can roll-over another’s IRA is the spouse.  Any other beneficiary must take a lump sum, or take a Beneficiary IRA. Or, to be safe, you could establish a trust so that the IRA is held for them in trust.


6. What do most beneficiaries decide to do when they find out they’re inheriting an IRA?

Most beneficiaries opt to take a lump sum, which Uncle Sam appreciates.  The custodians of IRA accounts – the Vanguards & Merrill Lynches of the world – are not very helpful to beneficiaries when they’re making this important decision.  A beneficiary only has one chance to get it right, and the lure of immediate money is hard to resist (fun fact: the average time between inheriting money and buying a new car?  19 days!).  An IRA Trust can be helpful because it will prevent the lump sum distribution, and force the beneficiary to take the Beneficiary IRA (Remember, another term for “stretch”). 

Ask yourself this… before reading this article, how much did you know about Stretch IRAs?  Figure that your own (younger, less experienced) beneficiaries will probably know less than you and will not understand the weight of their decision and how much money they may be leaving on the table.


7. My IRA is for my retirement, so why should I be worried about who inherits it?

People that believe they will spend down their IRAs in retirement often forget two concepts: First, they were and are savers, and that habit won’t change overnight. Second, they will only take their required minimum distribution because they don’t want to pay Uncle Sam one penny more than they have to. Most people that were “savers” during their working years will end up leaving significant IRAs as part of their estate, so it’s best to plan for the strong possibility that your heirs will inherit your IRA.


Like I wrote last week, if these questions and answers only raise more questions for you, it might be time to sit down and talk with me.  And the best time to act is “before it’s too late”, which is now.  So if you have a question of your own, give us a call at 215-706-0200.