Updated Thursday, July 24, 2014 as of 5:38 PM ET
Blogs - Ask Ed Slott
Making Smart Choices For IRA Beneficiaries
Thursday, August 9, 2012
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Ed Slott was named "The Best" source for IRA advice by The Wall Street Journal and called "America's IRA Expert" by Mutual Funds Magazine. He is a widely recognized professional speaker and educator specializing in retirement distribution planning, teaching both financial advisors and consumers how to best take advantage of our complicated tax code.

-- Have something you want to ask Ed? Send your questions to mailbag@irahelp.com

This week, IRA expert Ed Slott answers readers' questions about naming contingent beneficiaries for IRAs.

Question 1:

Ed,

I am 65 and have a number of IRAs ($500K) which all go to my wife if I die first. What should I do for my contingent beneficiary? Name her son or leave it to my estate? I have a will, which creates a family trust, which I would expect to take care of all my accounts. My wife can also choose to put these inherited assets in a trust. Does that complicate matters?

Thanks for your help!

Steve

Answer:

Generally, it is not advisable to name your estate as a primary or contingent beneficiary because death distribution options will be limited when an estate inherits an IRA. This is because an estate does not have a life expectancy and thus cannot stretch death distributions over a long period of time.

You could, however, name the family trust under the will as a beneficiary, which is essentially naming the family trust as beneficiary. In general, trusts do complicate matters.  If the trust does not qualify as a see-through trust, then death distribution options will also be limited. If you want your wife's son to inherit your IRAs, the simplest thing to do is to name him as the contingent beneficiary.

Question 2:

Hi Ed,

I work for the federal government and we have a program that I'm eligible for called the voluntary contribution program. It's an after-tax, tax-deferred account that I can make large contributions to at any time. So, I made a deposit and immediately converted the contribution to a Roth.

My understanding is that since the conversion was tax free (no earnings and moving from an after-tax non-IRA account to an after-tax Roth) I would be exempt from the five-year rule? What taxes and penalties would I be subject to before age 59 1/2 if any?

Also, my wife has done the same thing, but she was past age 59 1/2 at the time of the conversion. Is it different for her?

Thanks in advance for your help.

Canon

Answer:

There are two different five-year rules for Roth IRAs. There are also ordering rules for distributions. All Roth IRAs are considered one account for the purposes of these rules.

Annual contributions are considered to be distributed first. Distributions of these funds are always tax and penalty free.

Converted amounts are the next funds to be distributed. These funds are subject to the 10% early distribution penalty if they are distributed before the conversion has been held for five years or if you are under the age of 59 at the time of the distribution.  However, the penalty only applies to amounts that were taxable at the time of the conversion, so in your case, it appears that you are not subject to this penalty. This is one of the five-year rules.

Earnings are the last funds distributed. Earnings could be taxable and subject to the 10% early distribution penalty if the distribution is not a "qualified" distribution. For a distribution to be qualified you must have established any Roth IRA at least five years ago and you must be over the age of 59 at the time of the distribution.

If either you or your wife takes a Roth distribution that contains earnings before you meet these qualifications, you will be subject to income tax and you would be subject to the 10% penalty, if applicable, on the amount of the earnings distributed to you. This is the other five-year rule.

Question 3:

I have a substantial amount of company stock in my IRA that was rolled over from a 401(k). At the time it was worth substantially more (by a factor of three) and I didn't want to pay the taxes at that time so early in my retirement. I have the documentation relative to that stock just before my rollover. I have the tax cost per share info (average) on the shares in the account at that time.

The stock is essentially untouched with the exception that I have always re-invested the dividends in the IRA account. What are my options if any to minimize the tax consequences?

(1) Comment
I am here to say how I admire you advices. Thanx to answers I was able to help some of my friends who got into similar situations. Just like with the second question. I have a friend who also works for the federal government and have exactly the same question. Well, actually he had. I helped him with pointing to your advices, Ed. It is very nice of you to give a hand to people compeletaly free of chrage. I mean some people have to get out faxless loans in order to be able to get a professional adviser to answer their questions. Thanx again, Ed! I will definitely put my question here when I need a high quality advice!
Posted by David G | Wednesday, November 07 2012 at 4:47AM ET
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