What you Need to Know about your IRA James Terwilliger

IRAs are great retirement savings vehicles.

Yet, many IRA owners make critical mistakes that needlessly cost them or their heirs money or short circuit the owners' original intentions.

Here are some watch outs to help you guard against making some of the most common errors:

• Required Minimum Distributions - Even if you are still working, you are required to begin taking annual minimum distributions in the year you turn age 70-1/2. However, you have until April 1st following the year you turn age 70-1/2 to take out your first distribution. Subsequent years' distributions must be satisfied annually by December 31st of each year.
  
  The penalty for not withdrawing the required minimum amount at the right time is 50% of the difference between the amount taken out and the amount that should have been taken out. And that is on top of the income tax due on all amounts withdrawn. Don’t get caught in the 50% penalty trap!
• Waiting until the last Minute - You may not want to wait until the April 1 deadline to take your first required minimum distribution. You will have to take your second distribution by December 31 of that same year. Two minimum withdrawals in the same year could bump you into a higher tax bracket. Consider taking the first required distribution by December 31 of the preceding year.
  
  Also, owners of large accounts may actually reduce their tax bite by taking withdrawals during potentially lower-income years before they turn 70-1/2. That will decrease the required distributions later on.
• Multiple IRAs - The IRS offers flexibility here. You are not required to take minimum distributions from all accounts. You may, if you wish, "pool" your IRA balances, calculate the total minimum distribution required, and then allocate distributions from your IRAs as desired – taking none from one or more accounts, taking more from others, etc. The total amount withdrawn is what is important. It is important to notify your various IRA custodians if you wish to allocate your distributions differently from the prescribed formula. Otherwise, you may receive distributions you do not want.
• Name a Beneficiary - Failure to name a beneficiary usually means that the assets go to your estate. That will cost heirs money. If you hadn't already started required minimum distributions by the time of your death, the IRA assets must be distributed to your estate and ultimately to your heirs within 5 years of death. If you had started minimum distributions prior to death, distributions must be paid out to heirs over your remaining IRS-table life expectancy. Either way, this deprives heirs from stretching out the tax-deferred assets over their own lifetimes and creates a more-concentrated income tax bite.
• Name a Contingent Beneficiary(ies) - This allows the primary beneficiary to disclaim the IRA inheritance if he/she doesn’t need the money and automatically pass the IRA along to the contingent. Typically, the contingent is younger, allowing the IRA to be stretched out over a longer life expectancy. Also, having a contingent ensures that the IRA will not just pass to your estate in the event that your primary beneficiary predeceases you.
• Change your Beneficiary - Life events (marriage, divorce, birth, death, etc.) force changes in priorities and desired outcomes. It is critical that you keep your beneficiary designations up-to-date. Don't rely on your will. Your will has no influence on the disposition of your IRA assets (unless your IRA passes to your estate). Unfortunately, remembering to keep beneficiary designations current is something most folks neglect to do. Don't get caught in this trap. It can be disastrous.
• Charitable Option - Naming a charity as a beneficiary can have significant income tax benefits for your heirs, assuming charitable giving is a part of your estate plan. For example, if you have both IRAs and taxable accounts, consider leaving one or more IRAs directly to charity and the taxable accounts to your heirs. This way, no income taxes are payable on the "donated" IRAs, and your heirs receive a stepped-up tax cost basis for the taxable accounts. If done the opposite way, your heirs will ultimately pay income taxes on every dollar of IRA assets inherited.

How can a simple concept like an IRA get so complicated? Congress and the IRS have a way of doing that. Fortunately, they also gave us a wonderful savings vehicle. If you treat it properly, you can reap the rewards. Be sure to consult with a trusted financial professional to make sure you are doing all you can to maximize your benefits.

James Terwilliger, CERTIFIED FINANCIAL PLANNER™, is Vice President, Financial Planning, Wealth Strategies Group, Canandaigua National Bank & Trust Company. He can be reached at 585-419-0670-50630 or by email at jterwilliger@cnbank.com. This article previously appeared in Business Strategies Magazine.