Avoiding IRA Rollover Mistakes, Part 3

By Jon L. Ten Haagen

This week, we get into a bit more of the smaller but more complex mistakes that, if not addressed, can cost a lot in taxes and penalties.

Missing a net unrealized appreciated opportunity – If you work for a company and they offer shares of their stock in your IRA, this is for you. By taking advantage of net unrealized appreciation rules, it may be possible to significantly decrease the taxes owed on highly appreciated company stock held in the company-sponsored retirement plan. NUA can allow you to remove all or some of your company stock when you roll over your plan to an IRA.

How does NUA work? Your company stock is deposited into a taxable (non-IRA), and your remaining 401(k) assets are transferred into an IRA. You pay taxes on the stock based on its original cost. The tax owed on the difference is paid when you sell your shares. Again, work with a competent certified financial planner to determine if you can take advantage of this complex strategy. If you can, it can save you a lot in taxes. It you leave the stock in the IRA, when you sell and distribute monies you will be paying ordinary taxes at your current rate which can be significantly higher than by taking advantage of NUA.

Naming a trust rather than a spouse as primary beneficiary – If, like many owners, you have a living or grantor trust, you can name it as the beneficiary of your IRA. But if you have a surviving spouse, that may not result in optimal distribution options.

Here’s why: The death distribution rules for trust beneficiaries are much more restrictive than those for spouse beneficiaries. A spouse beneficiary can move the IRA assets into her or his own personal IRA – and then can name his or her own beneficiaries – including naming a trust. As your IRA’s beneficiary, your spouse can choose to move the IRA assets into an inherited IRA and take death distributions base on their own life expectancy – an option that may not be available to a trust beneficiary. Once more, a complicated decision to make without proper guidance.

Mishandling transfers of inherited IRAs to non-spousal beneficiaries – Many people mistakenly assume that the 60-day rule for rollovers applied to non-spousal beneficiaries of IRAs. In fact, if you are a non-spousal beneficiary, your taking receipt of IRA assets incurs as immediate taxable distribution. If you intend to transfer the IRA assets directly to an inherited IRA at another institution, you must do so in the form of a direct trustee-to-trustee transfer. There are also IRS rules that allow non-spousal beneficiaries to stretch out the required minimum distributions over a much longer period of time than the previous five-year maximum after death of the IRA owner. This means that if you are a non-spousal beneficiary, you can inherit IRA assets and receive RMDs based on your own life expectancy.

To make sure you don’t incur unnecessary taxes and to determine if stretching an inherited IRA would be advantageous to you, contact a qualified CFP before you transfer any assets you inherit.

A belated Happy Thanksgiving. Be thankful for our good health, the good year we have had, the many gifts we have received, and the lessons we have learned throughout the year and let us remember those who cannot be with us on this day. Be thankful for the bountiful meal we will be sharing with our families and friends. And be sure to thank our military people who make this freedom possible for all of us!