(PUB) Investing 2015

January 2 015

Morningstar FundInvestor

17

Slott: Years ago, it used to. But now, it generally does not, other than in a few situations. Again, it’s always going to come back to being very careful about naming the beneficiaries you want on the IRA benefi- ciary form—not in your will. The beneficiary form trumps the will. If you name beneficiaries on your beneficiary form, and they are individuals like your children or grandchildren, they can stretch the inher- ited IRA over their lives regardless of when you, being the IRA owner, died. It wouldn’t matter if you died before or after 70 1 / 2 . The only time it matters if you died before or after 70 1 / 2 is if you’ve neglected to name beneficiaries. So, you don’t have a designated beneficiary to the account. And in that case, many times your estate becomes the beneficiary by default. And the estate is not a designated beneficiary, so the stretch would be lost, and then special rules come into play depending on when the IRA owner died, before or after 70 1 / 2 . Benz: You noted that one of the key things you should definitely think twice about is just taking the money and running, because you trigger a big tax hit there. What are the other options, apart from taking an immediate distribution, that nonspouse beneficiaries have? Slott: Well, there is a trap even if you don’t think you’re taking an immediate distribution. Again, two words: Touch nothing. Let’s say you’re the child who inherited and [you] say, “Well, I want to invest it the way I want to invest it. My dad was too conservative. I’m going to move it from his IRA to my inherited IRA , and I’ll do investing in a different place. I didn’t like where we had the money.” Here is a situation where they don’t want to take all the money out; they just want to invest it differently. But once they take the money out, that’s the trap. It’s exposed. It’s over. It can’t be fixed; the whole thing is taxable.

You can still move it to the investment of your choice, but it can only be moved as a direct transfer—also called a trustee-to-trustee transfer, where you never touch the money. If you take a check out of that IRA — your dad’s IRA —it’s over. It’s taxable. It’s like an egg shell: If you break it, it’s over. The only way money can be moved is a direct transfer without you touching the money. That’s so important. If you touch the money, there is no more inherited IRA . It’s all taxable, and there is no fix for that. Slott: It has to be a properly titled inherited IRA , which means the name of the deceased IRA owner must remain in the account title. So, it would read something like “John Smith IRA , deceased, date of death, FBO ”—which stands for ‘for the benefit of’— ”John Smith Jr.” That’s a properly titled inherited IRA . That cannot be commingled with an inheritor’s own IRA . You do that, it’s over. There are so many rules in the inherited area where you can have a fatal error. When I say it’s over, it means the entire inherited IRA becomes taxable, and it all gets added to your income in one tax year. Benz: Assuming I’ve set up that inherited IRA separately and I’m a nonspouse beneficiary, what are my distribution options for that account after I’ve gone and done that? Slott: Then, you can stretch or extend distributions over your own life expectancy, which can be fantastic. Obviously, the younger you are, the better it is. For example, if you inherit it at, say, 30 years old, you can stretch it over 53 . 3 years. You can take minimum distributions over the rest of your life expectancy. It doesn’t matter what kind of health you are in or whether you think you are going to live long or short. But you have the ability, if you set everything up right, to stretch it over your lifetime or take more if you want to. The amount you have to take is simply the minimum. œ Contact Christine Benz at christine.benz@morningstar.com Benz: Is it important to set up an inherited IRA that’s separate from other IRA assets that I might have?