ED SLOTT S IRA ADVISOR

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1 ED SLOTT S IRA ADVISOR 2015 Ed Slott, CPA September 2015 Tax & Estate Planning For Your Retirement Savings A Step-By-Step Guide to Planning for Spousal Beneficiaries Death is simply a fact of life. It will happen to all of us at one point, and of course, to all of our clients. That simple, yet irrefutable, fact makes implementing good post-death planning strategies a must for advisors. Unfortunately, post-death IRA planning is rarely afforded the same level of simplicity as planning for other assets. There are a myriad of rules to follow, and failing to follow any one of them could lead to disastrous tax consequences for a bene ciary. urthermore, there are different rules for different types of bene ciaries, such as a spousal bene ciary versus a non-spouse bene ciary, which makes things all the more complicated. While it s not always the case, in the overwhelming majority of situations, married clients will name each other as their primary IRA bene ciary. Therefore, understanding the rules that apply when Post-death IRA planning is rarely afforded the same level of simplicity as planning for other assets. a spousal bene ciary inherits an IRA is of critical importance for advisors. When a spouse is considered a sole spouse e e there are three different options available to them. One option available to a spousal bene ciary and one that is o l available to spousal bene ciaries is known as a spous l ollo e. A spousal rollover is the name given to the planning strategy where a surviving spouse moves a deceased spouse s retirement account into their own retirement account. Despite its name, spousal rollovers may actually be accomplished via a 60-day rollover, a direct rollover or a trustee-totrustee transfer. After a spousal rollover is completed, the funds in the surviving spouse s IRA are treated as though they were l s in the surviving spouse s IRA. Put differently, the spouse is no longer treated as a bene ciary. Thus, if the deceased ARE YOU CAPITALIZING ON THE BABY BOOMER JACKPOT? Ed Slott and Company s Exclusive 2-Day IRA Workshop WHAT S INSIDE? pousal ene ciary Options Option pousal Rollover Option lect to Treat as Own Option Remaining a ene ciary eeting the ole pouse ene ciary Requirement elping pouse ene ciaries Choose the Right Option pousal Rollover Decision Tree es es FEBRUARY 19-20, 2016 LAS VEGAS SEE PAGE 8 FOR SPECIAL SAVINGS To Order Call: (800) ED SLOTT S IRA ADVISOR SE TE ER 01 1

2 spouse was 75, but the surviving spouse is 60, executing a spousal rollover can allow the surviving spouse to delay required minimum distributions for roughly another decade. The door, however, swings both ways. If a surviving spouse is under 59½ and executes a spousal rollover, the funds inside the surviving spouse s rollover IRA get the same have-always-been-in-the- IRA treatment. Therefore, if the surviving spouse needs to take a distribution of some or all of those funds prior to turning 59½, he/she will not only owe income tax on those funds, but the 0 early distribution penalty as well unless an exception to the penalty applies. A bene ciary including a spouse that chooses to remain a bene ciary of course, doesn t have this problem, since a bene ciary is never subject to the 0 penalty. It s also important to note that a spousal rollover is an irrevocable decision. Once the inherited funds have been rolled or transferred into a surviving spouse s own IRA, there is no way to go back and unwind the transaction, even if the move is clearly not in their best interest. The IR has no authority to undo this transaction and even in situations where clients receive blatantly wrong advice, they are stuck with the outcomes of those decisions (though bad advice could result in a civil suit, arbitration, or similar proceeding). Thus, getting this decision right the rst time and the only time is of the utmost importance. inally, advisors should be aware that there is no deadline to complete a spousal rollover. It can be made immediately after spouse s death, or perhaps, many years in the future after rst utili ing one of the other spousal bene ciary options available. A spousal rollover is an irrevocable decision. intentional or the mere fact that certain acts, or lack thereof, by a surviving spouse can deem the surviving spouse to have made the election to treat a deceased spouse s IRA account as their own. And much like a spousal rollover, once a surviving spouse has elected to treat their deceased spouse s IRA account as their own, there s no going back to being a bene ciary. The two most common actions/inactions of the surviving spouse that can deem them to have made the election to treat a deceased spouse s IRA as their own are: ) aking a contribution to the deceased IRA owner s account. ) ailing to take a required minimum distribution (R D), as a bene ciary. The third and nal option a sole spouse bene ciary has upon inheriting a deceased spouse s IRA account is the ability to remain a bene ciary of the account. That might sound weird at rst. After all, if the surviving spouse is inheriting an IRA, aren t they always the bene ciary Yes, but in name only. When discussing a surviving spouse s option to remain a bene ciary, practitioners are referring to the ability of the spouse to set up and maintain a properly titled inherited IRA account. The primary reason a surviving spouse would choose this option is to avoid the 0 penalty on pre-59½ distributions from the inherited account, though there are other potential reasons as well. A second option available to sole spouse bene ciaries the ability to treat a deceased spouse s IRA account as their own. In doing so, the surviving spouse essentially pretends as if they owned the deceased spouse s IRA account all along. ssentially, it can be view as a spousal rollover without having actually completed a spousal rollover. Not surprisingly then, tax treatment for a surviving spouse utili ing this option is virtually identical to the surviving spouse executing a spousal rollover. or this reason, as well as for practical purposes, the elect-totreat-as-own option is rarely used in the real world. Its intentional use has essentially been largely reduced to situations where a surviving spouse wants to maintain an existing IRA investment, but would not be able to do so if the deceased spouse s IRA account was closed. Note the precise wording of the last sentence; "Its e o l use has essentially " Why the use of the word When a surviving spouse chooses to remain a bene ciary of their deceased spouse s IRA account, they are subject to a strange set of rules. ome of the rules to which they are subject are exactly the same as those for non-spouse bene ciaries. Others, however, are completely different. or instance, just like a non-spouse bene ciary, if a surviving spouse that has chosen to remain a bene ciary wants to move their inherited funds from one account to another, they must do so via a trustee-to-trustee transfer. ene ciaries, including spousal bene ciaries, cannot execute 60-day rollovers (though a 60-day rollover could be used to complete a spousal rollover). imilarly, a surviving spouse that wishes to remain a bene ciary must make sure their inherited account is properly titled, both keeping their deceased spouse s name in the title, as well as indicating that the account is a bene ciary or inherited IRA. An example of proper titling is: o Doe (de ea ed ) IRA O a e Doe o what rules, then, are different for a spouse who chooses to remain a bene ciary of their deceased spouse s ED SLOTT S IRA ADVISOR SE TE ER 01 To Order Call: (800)

3 A Step-By-Step Guide to Planning for Spousal Beneficiaries Summary of Key Points Sole Spouse e e iaries a e T ree Op io s ) pousal rollover ) lect-to-treat-as-own ) Remain a bene ciary There are several special rules for spouses who choose to remain a bene ciary They can recalculate their life expectancy each year using the ingle ife xpectancy Table There are no R Ds for the inherited IRA if the deceased spouse would not yet be 70½ If the "surviving spouse" dies before the original deceased spouse would have been 70½, then the surviving spouse s own bene ciaries can use their ages to calculate R Ds after they inherit A e is e Dri i a or e i d os Spousal e e iar De isio s Sur i i Spouse is der Sur i i Spouse is or Older T pi al la i S ra e : Remain a bene ciary until surviving spouse reaches 59½, then execute a spousal rollover os ommo ex ep io o pi al pla i s ra e : Deceased spouse was/would have been over 70½ and surviving spouse does not think they will need to access inherited IRA funds prior to their age 59½ IRA versus those for non-spouse bene ciaries It all comes down to R Ds, both for the surviving spouse themselves, as well as their own bene ciaries down the line. S e al R le or Cal la R D D r Spouse s Life - If a surviving spouse chooses to remain a bene ciary of a deceased spouse s IRA, there are special rules used to calculate R Ds. In fact, in some cases, there may be no R D at all. When a surviving spouse chooses to remain a bene ciary of an IRA, they are not subject to required minimum distributions until the deceased spouse would have been 70½. Example #1: Janet is 50 years old and has recently inherited an IRA from her husband, who was also 50. If Janet chooses to establish an inherited IRA, she would have no required minimum distributions from that account for the next 0 years, even though she s a bene ciary If Janet had been a non-spouse bene ciary R Ds would need to begin in the year after she inherited. That s not the only R D advantage a spousal bene ciary gets. ven when a spousal bene ciary is subject to required distributions on their inherited account, they get a special break when calculating that amount. Non-spouse bene ciaries of an inherited IRA calculate R Ds by looking at the ingle ife xpectancy Table in the year after they inherit to determine their initial life expectancy factor. Then, they subtract one in T pi al la i S ra e : xecute a spousal rollover (this can be done immediately) os ommo ex ep io o pi al pla i s ra e : urviving spouse is older than the deceased spouse (who was not/would not yet be 70½) and the surviving spouse wants to delay R Ds for as long as possible each successive year to determine their new R D factor, until the account is empty. pousal bene ciaries, on the other hand, have the advantage of being able to recalculate their life expectancy. That sounds like some type of futuristic medical procedure, but in terms of the tax rules, all it means is that a spousal bene ciary subject to required minimum distributions can look at the ingle ife xpectancy Table each and every year to determine their R D. Over time, this results in lower R Ds for spousal bene ciaries when compared with non-spouse bene ciaries. Example # : Cindy turned 0 years old in 0 5 and inherited an IRA from her 74-year-old husband last year. Due to her young age, Cindy has decided to remain a bene ciary of the account. In 0 5, Cindy will use her 40 year-old age to look up her life expectancy factor on the ingle ife xpectancy Table. Doing so will result in a factor of 4.6. ach year, going forward, Cindy will continue to use her current age to look up her life expectancy factor using the ingle xpectancy ife Table. o, 5 years later when Cindy is 55, her life expectancy factor will be 9.6. In contrast, if Cindy had been a nonspouse bene ciary, her life expectancy factor at that time would be.6 ( ). Spe ial Rules for Su essor e e iaries - In general, once a bene ciary inherits an IRA, the life To Order Call: (800) ED SLOTT S IRA ADVISOR SE TE ER 01 3

4 expectancy for all future bene ciaries, known as successor bene ciaries, is set and cannot be changed. or instance, if Grandma dies and leaves her IRA to Child, and then Child dies, leaving the inherited IRA to Grandchild, then Grandchild, as a successor bene ciary, will be stuck using Child s life expectancy to calculate R Ds from the inherited IRA. That s not always true though when a spouse inherits an IRA. If a surviving spouse bene ciary dies before the deceased spouse would have been 70½, then the spousal bene ciary s own bene ciary can use their own life expectancy to calculate required minimum distributions for the inherited IRA. Example #3: ike and abrina are married and are both 45 years old when abrina passes away. ike chooses to remain a bene ciary of abrina s IRA and names their child, aggie, as his bene ciary. Tragically, ve years later ike passes away. ince abrina would not yet have been 70½ years old, aggie will be able to calculate R Ds using her own life expectancy. Example #4: Al and dna are married. Al is 6, and dna is 5 when Al passes away. dna chooses to remain a bene ciary of Al s IRA and names their child, Oscar, as her bene ciary. adly, when dna is 57, she passes away. In this case, Oscar will inherit whatever is left of dna s inherited IRA, but since Al would have been 7 (older than 70½) at the time of dna s death, Oscar will be stuck using her remaining life expectancy to calculate R Ds until the account is depleted. In general, when a couple is married, each person will name their spouse as their sole bene ciary. In such cases, the sole spouse requirement is already met. Occasionally, however, a spouse will be named as a partial bene ciary of an account. This is particularly common in second marriage situations, where the decedent s IRA is split between their spouse and their children, often from a previous marriage. Would such a scenario prevent the surviving spouse from utili ing the special rules for spousal bene ciaries No, at least not if proper action is taken after death. If a spouse has been named along with other individuals/ entities as the bene ciary of an IRA owner s account, they can be treated as a sole spouse bene ciary provided the other bene ciaries are either timely cashed out or the account is timely split into separate shares. The deadline to timely cash out a bene ciary of an inherited IRA is eptember 0 of the year after the year of death of the account owner. The deadline to timely split an inherited IRA is December of the year after the year of death. In the overwhelming majority of situations, a spouse should remain the beneficiary of a deceased spouse s IRA if they are under 59½. Example # : ally is the bene ciary of 90 of her husband, Craig s, IRA. The remaining 0 of Craig s IRA was left to the alvation Army (a charity). If no action is timely taken, ally will not be able to use the special rules for a spousal bene ciary (in fact, if no action is timely taken she d be stuck using the post-death distribution rules for a non-designated bene ciary, since the charity has no life expectancy). If, however, the alvation Army receives its 0 share of Craig s IRA by eptember 0 of the year following the year of his death, ally will be treated as a sole spouse bene ciary of the remaining account balance and will be able to utili e any of the special spouse-only rules. Example #6: Jerry is the bene ciary of 50 of his wife, Paula s, IRA. The other 50 of Paula s IRA was left to her child from a previous marriage. If no action is timely taken, Jerry will not be able to use the special rules for a spousal bene ciary. owever, if Jerry s share of the inherited IRA is split out into a separate inherited IRA by December of the year following Paula s death, he will be able to utili e any of the special spouse-only rules. Knowing the options that a spousal bene ciary has after they inherit an IRA account and choosing which option is best are two very different things. o how does one go about helping clients decide which option to choose? Well, in most cases, it can be boiled down to simply a matter of age. In the overwhelming majority of situations, a spouse should remain the bene ciary of a deceased spouse s IRA if they are under 59½. Then, once they reach 59½, or if they are already 59½ or older when they inherit, they should execute a spousal rollover. Why is this almost always the correct course of action? ecause there is very rarely a downside for doing so. Example #7: Vince and Charlotte are married and are both 50 years old. They have also named each other as the sole bene ciary of their IRAs. Unfortunately, Vince passes away. In this case, it s almost a virtual certainty that Charlotte should establish a properly titled inherited IRA. Doing so would afford her the ability to take penaltyfree distributions from her inherited IRA for the next 9½ years, until she reaches 59½. Then, when she reaches 59½, she should execute a spousal rollover into her own IRA. ut what if Vince had millions and millions of dollars of life insurance and Charlotte is convinced that she will never need to touch the money until 59½? ven in this case, establishing a properly titled inherited IRA is probably going to be the best bet. What s the downside? 6 ED SLOTT S IRA ADVISOR SE TE ER 01 To Order Call: (800)

5 Will Charlotte have required minimum distributions? No, because Vince would not yet be 70½. What if Charlotte dies? Will her bene ciaries be stuck using her life expectancy? No, because Vince would not yet be 70½. What if Charlotte's situation changes? Will establishing an inherited IRA afford her additional exibility? Absolutely Clients are often sure they will not need to touch retirement account money prior to 59½ until they actually do need to touch retirement account money prior to 59½. o, if you can nd a way to make that money accessible without any negative consequences, why not do it? e e ses su s e es e oul o e le o e ep s e e o e o ou s s p o s pl o e o s e l po oul e plo o e op o s It should be noted that while a spousal bene ciary s age is overwhelmingly the driving factor between deciding whether or not they should remain a bene ciary or execute a spousal rollover (bene ciary is under 59½, spousal rollover at 59½ or older), there are occasionally other factors that must be considered. There are two situations which, while occurring relatively infrequently, are the most common reasons to buck the age 59½ decision-making formula. 1) A ou spouse i eri s a IRA from a mu older spouse a d is er ai e o eed o ap e i eri ed IRA prior o a e ost of the time, spouses are relatively close in age. Occasionally, however, spouses may be several decades, if not more, apart in age. In such cases, if the younger spouse inherits an IRA from their much older spouse, they will have a decision to make. Do they want to establish an inherited IRA in order to have penalty-free access to the inherited funds prior to 59½, but give up R D bene ts for themselves, as well as potentially for their future bene ciaries? Or, do they want to execute a spousal rollover in order to defer R Ds until they turn 70½ and enhance their own bene ciaries R D options at the expense of penalty-free distributions prior to 59½? If that young spouse is con dent they won t need the inherited IRA funds prior to their own age 59½, the latter is probably a better choice. Example #8: Gloria is 40 years old and is married to Jay who is 7. Jay has a million IRA, as well as a 0 million life insurance policy, and has named Gloria as the sole bene ciary of both. Unfortunately, Jay dies. In most cases, Gloria s best move would be to establish an inherited IRA since she is 40 years old. owever, in this case, since Jay is over 70½ already, doing so would require Gloria to take required minimum distributions from the inherited IRA. It would also mean that if she died, Gloria s own bene ciaries, such as her children, would be stuck using her life expectancy, instead of their Age is overwhelmingly the driving factor between deciding whether or not a spouse should remain a beneficiary or execute a spousal rollover, but there are other factors to consider. own. As result, in this case, believing that 0 million will be enough to last her until 59½, Gloria s best bet may be to execute a spousal rollover. In doing so, she will be able to delay R Ds until she reaches 70½, and will be able to preserve the stretch for bene ciaries. These bene ts probably outweigh the risk of needing to tap any of the inherited IRA money prior to her reaching 59½. ) A Older Spouse I eri s a IRA a d a s o Dela R Ds as Lo as ossi le In most cases, an older spouse will die before their younger counterpart. ost cases though, are not ll cases. Occasionally, an older spouse will inherit an IRA from a younger spouse. If that happens when the younger deceased spouse was not yet 70½ and the surviving spouse wants to delay R Ds for as long as possible, then it may pay to set up an inherited IRA, even if the surviving spouse is already over 59½. y doing so, the surviving spouse can actually delay R Ds until the younger spouse would have been 70½. Example # : Ken, 7, is married to Rachel, 64. Rachel dies, leaving her IRA to Ken, who has plenty of other assets and wants to minimi e his income as much as possible to reduce his tax liability. If Ken executes a spousal rollover, he will need to begin taking R Ds the following year, since the funds will be treated as if they were always in his account and he is already over 70½. Thus, the better course of action and contrary to conventional wisdom may be to establish an inherited IRA for Ken and have him remain as a bene ciary. y doing so, Ken can take advantage of the special rules for spouse bene ciaries and delay R Ds until Rachel would have been 70½, giving him six and a half more R D-free years. Clearly, the decision of what to do as a surviving spouse is far more complicated than it might seem at rst. To that end, we ve created a Spousal IRA e e iar Decision Tree to help you properly guide clients, which you can nd on pages 4 and 5 of this newsletter. ach green leaf will ask a question. Answering the question via the options in the brown arrows will either lead you to another green leaf question, or to an orange leaf result. Once you reach your result, you ll know what to do in order to maximi e tax ef ciencies while working within the con nes of a client s most important objectives (i.e. penalty-free access to funds or more favorable R D rules). ue o e o e e s o o ele o e e e se spouse s s o e s o s s l p o spous l ollo e e pous l e s o ee o l o e pl es e e e e e u spous l ollo e To Order Call: (800) ED SLOTT S IRA ADVISOR SE TE ER 01 7