Inherited IRA FAQ
Sep/090
What is an Inherited IRA?
An inherited IRA allows a spouse or non-spouse beneficiary of an IRA to keep his inherited IRA assets tax-deferred until the IRS requires the funds to be distributed. When the account holder dies, a spouse beneficiary may either transfer the assets into an inherited IRA, complete a spousal transfer and treat the assets as his/her own. A non-spouse beneficiary may transfer the assets into an inherited IRA in his/her own name, and begin taking distributions on a distribution schedule based on his life expectancy.
Who can open an Inherited IRA?
Any spouse or non-spouse beneficiary of a Traditional, Rollover, SEP, SIMPLE or Roth IRA can open an Inherited IRA. With an Inherited IRA, the assets can remain tax-deferred – until IRS regulations require that they be withdrawn.
If I am a non-spouse beneficiary, can I just roll the IRA assets I inherit into an existing IRA account?
No, only spouse beneficiaries can treat inherited IRA assets as their own by transferring the assets into an existing or new (non-inherited) IRA.
Can I make additional contributions to my Inherited IRA?
No, contributions to Inherited IRAs are not permitted.
What are the rules for taking distributions from an Inherited IRA?
A beneficiary must first transfer the funds into a beneficiary IRA account. If he/she chooses not to take a lump sum distributions, there are several different options governing the amount and time frame of the distributions depending on several factors such as age, type of IRA, and type of beneficiary.
When can I take money out of my Inherited IRA?
You can make redemptions from an Inherited IRA at any time after it is re-registered into your own name.
Am I required to take money out of my Inherited IRA?
As the owner of an inherited IRA you may be required to either liquidate the account within five years of the December following the original owner’s death OR to choose by September of the year following the original owner’s death to take substantially equal payments over the longer of yours or the original owner’s life expectancy.
What is the deadline for establishing separate “inherited IRAs” so that each beneficiary can use his/her own life expectancy to measure MRDs?
The deadline is Dec. 31 of the year after the year the IRA owner died. The beneficiaries can split up an inherited IRA at a later date; however, a division occurring after the above deadline would not be effective to change the applicable life expectancy for measuring MRDs. All beneficiaries would have to use the oldest beneficiary’s life expectancy to measure MRDs if the “separate accounts” are not established by the end of the year after the year of death.
Inherited IRAs
Aug/090
When our loved ones die and leave behind assets in an IRA account, it is an opportunity to make sure we benefit from continued tax-deferral of investment assets. Tax deferral is one of our favored strategies for building wealth, and we need to preserve tax-deferral whenever we have the opportunity. This article will help guide you through the decision points of an inherited IRA. You’ll need to know:
1. The type of IRA beneficiary – spouse, non-spouse, estate, trust or charity.
2. The type of IRA – Traditional or Roth.
3. The age of the IRA account owner at the time of death.
4. The date the IRA account was opened if a Roth IRA.
Spouse Beneficiary
A spouse inheriting an IRA has the most options, but most likely has the easiest decision.
1. Spousal Transfer – You move the assets into your own IRA (an existing one or a new account set up for the purpose). You get to treat the assets just like your own IRA holdings, and they are subject to all the rules that apply to you as an IRA holder. You get to designate your own beneficiary. Spouses who are not the sole beneficiaries are not allowed to use this option. We would recommend most every sole beneficiary spouse take this option and perform a spousal transfer.
2. Lump Sum Distribution - All the assets are withdrawn, immediately. If the funds are subject to taxes, they must be paid all at once. There is no early withdrawal penalty. We would only recommend this option to a spouse who is significantly far away from reaching 59 and 1/2 years and will need the money immediately.
3. Inherited IRA 5-year option - The assets are transferred into a special IRA account called an Inherited IRA and must be distributed by the end of the fifth year after the death of the original account holder. You get to designate your own beneficiary. This option is not available if your spouse was over age 70 1/2. We don’t see a need for a spouse as sole beneficiary to use this option.
4. Inherited IRA Life Expectancy option – The assets are transferred into an Inherited IRA account (or separate Inherited IRA accounts, if there are multiple beneficiaries) and annual distributions are made based on the life expectancy of those who have inherited the IRA. You get to designate your own beneficiary. We don’t see a need for a spouse as sole beneficiary to use this option.
Non-spouse Beneficiary
A non-spouse inheriting an IRA has fewer options.
1. Lump Sum Distribution - All the assets are withdrawn, immediately. If the funds are subject to taxes, they must be paid all at once. There is no early withdrawal penalty. We would only recommend this option to a person who is significantly far away from reaching 59 and 1/2 years and will need the money immediately to payoff debt or for other major expenses such as paying for college.
2. Inherited IRA 5-year option - The assets are transferred into a special IRA account called an Inherited IRA and must be distributed by the end of the fifth year after the death of the original account holder. You get to designate your own beneficiary.
3. Inherited IRA Life Expectancy option - The assets are transferred into an Inherited IRA account (or separate Inherited IRA accounts, if there are multiple beneficiaries) and annual distributions are made based on the life expectancy of those who have inherited the IRA. You get to designate your own beneficiary. We see this as the most popular option for non-spouse beneficiaries option.
This information is intended to give a quick overview of the issues related to inherited IRAs. We suggest seeking the advice of a tax attorney. Also, please use the IRS publication on this topic.
If you would like to discuss you Inherited IRA situation in more detail, please call me at (813) 282-7870 or send me an email at derek.pilecki@gatorcapital.com.
Derek Pilecki
Gator Capital Management
(813) 282-7870
derek.pilecki@gatorcapital.com
Roth IRA FAQ
Aug/090
I recommend my clients use a Roth IRA to grow their retirement savings tax-free. Because I know the various types of IRAs can seem a little confusing, I thought I’d take some time today to answer the questions I get most often from clients.
What is a Roth IRA?
The Roth IRA is a type of individual retirement account that features tax-free withdrawals because the original contributions are made with after-tax money.
What’s the difference between a Roth IRA and traditional IRA?
There are several differences. The main one is when you pay taxes. With a traditional IRA, you invest pre-tax dollars and defer paying income tax until you take the distributions from the account during retirement. With a Roth, you pay income tax on the dollars you’re investing now—but when you take the distributions, they’re tax-free.
Other important differences have to do with the timing of your withdrawals. With either type of IRA, you need to wait until age 59 ½ to make withdrawals. But with a traditional IRA, you must begin making withdrawals at age 70 ½, or else you will face penalties. With a Roth, there is no required minimum distribution. If you don’t need the money in your Roth IRA when you’re 70 ½, you can leave it there to keep growing.
Am I eligible to set up and contribute to a Roth IRA?
In order to contribute to a Roth IRA in 2009, you need to have taxable income for the year, and your adjusted gross income must be less than $166,000 if you are married filing jointly or $105,000 if you are single. (In addition, there’s a category in which you are allowed to contribute but your contribution limit is lower: for those married filling jointly whose AGI is between $166,000 and $176,000 or single with AGI between $105,000 and $120,000).
How much can I contribute to a Roth IRA?
In 2009, you can contribute up to $5,000 or up to $6,000 if you are 50 or older. If you are also contributing to a traditional IRA, then your total contributions to both IRA accounts may not exceed these same limits (so, for example, if you are under 50 and you put $2,500 into a traditional IRA, then you may only put $2,500 into a Roth IRA).
When can I set up a Roth IRA?
You can set up a Roth IRA at any time. You can make contributions for the previous year up to the date your taxes are due. For most people, then, you can make contributions for 2009 up until April 15, 2010. (This can be useful if you decide to set up a plan in January and want to make up time by, say, contributing 2009’s total early in 2010 and then making contributions throughout the year for 2010.)
Will I save more on my taxes with a Roth IRA or a traditional IRA?
Generally, you will have higher after-tax returns with a Roth IRA. One of the benefits of a Roth IRA that I haven’t mentioned is you effectively are able to put more after tax money into tax-deferral with a Roth IRA. For example, if you make a $5,000 contribution to a traditional IRA, you are investing $5,000 of pre-tax money in to a tax deferred account. If you took that same $5,000 of pre-tax money and invested in a Roth IRA, had the same investment experience and had the same tax rate at retirement that you have now, you would have an identical sum to the traditional IRA. However, because the $5,000 of pre-tax money is $3,600 of after-tax money (assuming a 28% tax rate,) you can effectively save $1,400 more after-tax with a Roth IRA.
One factor that can work against you in a Roth IRA is if you are currently in a high tax bracket and expect to be in a lower tax bracket in retirement. However, because of the advantages of higher after-tax investment and the no required distribution aspect of a Roth IRA, I generally think the Roth IRA is a good choice for most people.
What are Roth IRA Qualified Distributions?
Qualified Distributions from a Roth IRA are tax and penalty free. In order to be a qualified distribution, there are two requirements that must be met:
1. The distribution must occur at least five years after the Roth IRA was first established and funded; and,
2. One of the following requirements also must be met:
a. The Roth IRA owner must be at least age 59 1/2 years old,
b. Distributed assets limited to $10,000 are used towards the purchase of a first home for the Roth IRA holder or a qualified family member,
c. The Roth IRA owner is disabled; or,
d. The assets are distributed to the beneficiary of the Roth IRA owner after the owner’s death.
Distributions that do not meet the above criteria are considered non-qualified and may be subject to income tax and a 10% early distribution penalties.
Are there any other allowed early distributions from a Roth IRA?
In addition, the 10% early penalty is also waived for certain other distribution reasons. But, for these distributions, taxes on any earnings will apply. The types of distributions that are subject to taxes on any earnings withdrawn but with no penalty include:
1. Substantially equal periodic payments,
2. Eligible medical expenses in excess of 7.5 percent of your adjusted gross income (AGI),
3. Medical insurance premiums for eligible unemployed individuals,
4. Qualified education expenses; and,
5. Distributions taken within the first five years for any of these reasons: age 59½, death, disability, or first-time home purchase.
Distributions taken for any reason other than a qualified reason or one of the reasons here are subject to both taxes and a 10 percent IRS penalty on any earnings withdrawn.
Are the investment options the same for Roth as for traditional?
Yes, just as with a traditional IRA, funds inside a Roth IRA can be invested in a wide range of securities, including stocks, bonds, and money market accounts. Your exact investment options will depend on the financial institution where you set up the Roth IRA account. We custody our clients’ Roth IRA accounts at Fidelity Investments because of there are no annual fees, discounted brokerage commissions, and strong investment platform with many investment options.
Can I leave my Roth IRA to my heirs?
Yes, and this is another area in which the Roth has some advantages; unlike with a traditional IRA, your heirs can keep the inherited money from a Roth IRA in the account beyond the time when you would have reached 70 ½. Since there are no required minimum distributions, you heirs will join the opportunity to compound their investment returns tax-free for a longer period of time than if you had a traditional IRA.
How Do I Open a Roth IRA Account?
We would be happy to help you open a Roth IRA account. As we mentioned, we have our clients open their Roth IRA accounts at Fidelity Investments. Please call me at (813) 282-7870 or send me an email, and we’ll help you open your Roth IRA account.
Derek Pilecki
Gator Capital Management
(813) 282-7870
derek.pilecki@gatorcapital.com
IRA Tips
Jul/091
These days, many of us feel retirement is getting further away. That’s all the more reason to review your retirement plan, evaluate your current IRA, and make adjustments if necessary. Too many people establish IRAs with a one-time contribution, without giving any more thought to their retirement plan.
Review you investment choices – With the market downdraft of late 2008, many people aren’t opening their brokerage statements. This is natural because the emotional pain of financial losses is something we want to avoid. However, the best thing to do is open the statement look at the current portfolio and make changes. It is likely that you are overweight bonds compared to your planned stock/bond weighting. It is a good time to rebalance your portfolio by moving some money out of bonds and into stocks.
Diversify your investments - One rule of thumb for a moderate risk portfolio is to invest the same percentage as your age in bonds and the rest in stocks. If you are 50 years old, put 50% in bonds and 50% in stocks. If you are 30 years old, put 30% in bonds and 70% in stocks. It is important to rebalance back to these ratios periodically. Rebalancing tends to reduce risk and smooth performance over the longer-term because when you rebalance, you tend to buy stocks after they decline and sell them after they have risen.
Should I put money in an IRA or a 401k - If you don’t have an IRA at all and are relying solely on a 401k for retirement, consider the advantages of diversifying your retirement savings by adding an IRA. Unlike 401ks, an IRA allows you to access your money before retirement if necessary—yes, there are penalties. But if all your retirement savings are in a 401k and you suddenly have a catastrophic loss, your 401k won’t give you the flexibility you’ll need.
Make sure you take advantage of employer matching - Does that mean you should stop contributing to an employer retirement plan and put all your money into an IRA? Probably not. If your employer provides any matching contributions, you should make sure before anything else that you’re taking full advantage of the matching. (Remember, employer matching is free money, but it earns interest just like the contributions you make yourself—so it’s the most valuable way of building your retirement savings). But if you’re currently contributing more than necessary to get the matching (or if you could afford to contribute more than that), the excess should probably be going into an IRA, which will give you more investment options, better returns, and more flexibility.
Consider converting to a Roth IRA - If you’re already in a traditional IRA and you’re under the income limit for Roth IRAs, consider converting. In 2009, the income limit has been increased to $169,000 for married filing jointly or $116,000 for single. If you are under the income limits, it makes good sense to convert your traditional IRA account to a Roth. With a Roth, you’ll pay taxes on the contributions you make now, but you won’t be taxed on the dividends when you begin to take those out. And there won’t be any mandatory disbursements at age 70 ½ either. For most people, the Roth makes more sense.
Converting to a Roth IRA will affect your taxes - There are some tax adjustments that will impact your taxes the year that you convert, so make sure you understand how this change will affect you before converting. Beginning in 2010, the rules on converting other retirement accounts to Roth IRAs will be relaxed, so if you’re considering conversion, you might want to wait until 2010.
Don’t Open an IRA at a Bank – Bankers love IRA deposit accounts because they are sticky accounts that they can price very low. Don’t let your IRA get crummy interest rates from some banker. Plus you limit your investment options by having your IRA account at a bank. Instead, I like to advise clients to open an IRA account at a major discount brokerage firm such as Fidelity, Schwab or TD Ameritrade. If you want to put your IRA in a bank account for stability, each of these brokers has an option to move your money into a bank account within your IRA. Plus, they always pay competitive rates on their bank accounts.
Don’t invest in tax-free or tax-deferral investment in an IRA – The major benefit of an IRA is tax deferral, so you want to avoid investing in other tax saving investments such as municipal bonds or annuities within your IRA. Municipal bonds usually have lower absolute returns because of their tax-free status, but within an IRA, you get no benefit from the tax-free nature. Annuities qualify for tax-deferral because they are insurance contracts, but the insurance company charges a layer of fees for their services. It is better to invest directly in mutual funds within your IRA to avoid the insurance fee of an annuity.
Avoid investing in Master Limited Partnerships in your IRA – Master Limited Partnerships (MLPs) make your taxes much more complicated if you own them in your IRA. MLPs aren’t taxed at the partnership level. They are pass-through entities and their owners have to pay taxes. You might think you wouldn’t have to pay the taxes if you made the investment in an IRA, but the IRS will require your custodian to pay the UBTI at the corporate tax rate with funds from your IRA. Then, when you withdraw the money from your IRA, you’ll get taxed as usual. Plus, there is the potential administrative hassle of your IRA custodian overlooking paying the tax. Some make the argument that the potential of having to pay the UBTI is very low if you have less than $5 million because MLPs investing in pipelines usually report losses due to depreciation on the pipelines for tax purposes. On the other hand, several MLPs in the asset management sector do or may report substantial amounts of income such as Alliance Bernstein, Blackstone and Fortress Investment. To be safe, I’d keep MLP investments in a taxable account and out of an IRA.
Try to make the maximum contribution each year - Whether you’re contributing to a traditional or Roth IRA (or both), you should come as close to the contribution limit as you can afford to. The limit in 2009 is $5,000, or for those over 50, $6,000. If you have more than one IRA account, this limit applies to the combined total of all your IRA contributions for the year.
Maximum contribution are tough on young adults but worth it in the long run - While $5,000 annually can seem like a lot to young people who are just getting established, your goal should be to reach the limit as early in your career as possible, since the retirement savings you make when you’re young have the most time to compound before you retire. For those just beginning their working careers, the question might be “How much can I afford to contribute?” but as soon as possible, you should be asking “How much do I need to contribute to my retirement savings in order to retire when I want to and do the things I want to in retirement?”
Under some circumstances, extra contributions are allowed - Have you worked for an employer in the past who went into bankruptcy? If you were contributing to a 401k with that employer, under a certain set of circumstances, you may be eligible to make a higher annual level of contribution to your IRA account—and if you can, you should definitely take advantage of these catch-up contributions.
Keep track of deadline dates for IRA contributions - If you’re looking for the tax savings that contributions to a traditional IRA offer, you should keep in mind that contributions for a given year can be made from January 1 of that year to tax filing day (so in 2009, you can make IRA contributions between January 1, 2009 and April 15, 2010, in order to exclude contributed amounts from your 2009 tax return). If you do decide to make a contribution in that pre-tax day window from January to April 15 for the previous year, be sure to mark the tax year for which the contribution is being made on the check you write—otherwise it will be assumed to be a contribution for the year in which it was made.
Review your beneficiaries - If you’ve been contributing to an IRA for a while, it’s a good idea to check on the beneficiary you named when you opened the account. Since IRAs can be inherited, you want to make sure that the right names are listed. Ideally, of course, you’ll be the one enjoying your retirement savings, but just in case, an occasional review is a good idea. Also make sure that you’ve recorded the location of your IRA accounts and the names of their beneficiaries along with other instructions for those who will execute your wishes in case of your death.
Make sure to start taking minimum distributions - If your 70 ½ birthday is in sight and you hold a traditional IRA, remember that you’re required to begin taking minimum distributions no later than April 1 of the calendar year following the year in which you turn 70 ½. If you miss the deadline, you’ll get hit with tax penalties.
While IRAs do require some consistent attention over the years, they are one of the best ways to accumulate the funds you’ll want for a comfortable retirement. Now more than ever, it’s time to get planning. If you have any questions or want help with your IRA, please call or email me.
Derek Pilecki
Gator Capital Management
derek.pilecki@gatorcapital.com
(813) 282-7870
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