A $367,000 Mistake
I was recently referred to a gentleman who was in a lot of pain.
His situation is so important that I’ve decided to share it with you because it will reinforce a very important strategy and potentially help you and your family avoid a catastrophic mistake.
Although they were both in their late 80s, he lost his father and then his mother in less than 13 months.
That’s a lot for anyone to experience. It doesn’t matter how old his parents were.
Having lost my mother at the young age of 57, I can certainly sympathize. It’s never easy.
To compound his problems, and the reason why I was referred to him, was that he was just presented with a $367,000 income tax bill.
Let me repeat that: $367,000 in income taxes!
How’s that for pain?
Now, why did he owe $367,000 in income taxes?
The answer is that he unknowingly mishandled his parents IRAs after they passed away.
How sad is that?
As you can imagine, he was devastated.
He was very angry, not only at the company where his parents’ IRA was held, but at himself for not knowing any better.
How You Can Avoid This Tragedy
This tragedy reminded me to constantly reinforce how your children can properly handle inheriting your IRA so your assets don’t mistakenly end up in the hands of the government.
Landmines are everywhere. If your children are not informed, almost half of your IRA could get lost to taxes in one fell swoop!
That doesn’t sound too inviting, so let’s take this opportunity to walk through an example of how your children and grandchildren can make an “informed” decision when they inherit the IRA that you’ve taken your entire lifetime to build.
Bill and Agnes
Bill and Agnes been married for 40 years, and have 3 children who are all out of college and in the workforce.
After Bill retired, he rolled over his 401(k) and pension plan to an IRA where he named his wife Agnes as his primary beneficiary and his 3 children as secondary (or contingent) beneficiaries in equal shares.
Two years into retirement, Bill suffers a heart attack and passes away. (Sorry for the blunt shock value of the story, but it’s necessary to make the point)
When Bill passes away, as Bill’s spouse and beneficiary, Agnes may transfer the money that was in Bill’s IRA into her IRA without paying any taxes. (Key point: ONLY spouses can do this.)
Now, let’s fast forward ahead 3 more years. Agnes gets sick, and after a long battle, she passes away.
At this point, Agnes’ children have some decisions to make as the beneficiaries of their deceased mother’s IRA.
In far too many situations, and as was the case with the gentleman I just met, here’s what happens:
They call the institution where the IRA was held (bank, investment firm, insurance company, etc.) to inform them that their mother has passed away and to find out what their options are.
Depending on who receives that phone call, here’s the answer that they’re likely to hear:
“We’re very sorry to hear about your loss. We’re going to send you out an IRA distribution request form. Please each sign the form and return it to us along with a certified death certificate and we’ll get the checks out to you within 7 to 10 business days.”
Sounds simple enough, right?
What just happened?
Income Taxes Now Due on the ENTIRE IRA
The children just paid income taxes on the entire balance of the money in the IRA!
Depending on their own personal tax brackets, it’s likely that they gave up 40+% of their share in federal and state income taxes in one fell swoop!
As in the gentleman’s situation that I shared with you, $367,000 instantly went to pay federal and state income taxes!
Imagine that. You work your entire life. You diligently save your money. You select sound investments. You do everything right and with one phone call to an uninformed company representative, 40+% of your hard-earned savings is gone in one shot!
What Should They Have Done?
Each of the kids actually had another option with their share of their mother’s IRA. One option was to just cash it all out. But, as I mentioned, that has enormous tax consequences.
The second option, which is all too often omitted from the discussion, is to “re-title” their portion to an Inherited IRA, leaving their deceased mother as the deceased owner of the IRA and them as the beneficiary.
By doing this, they are only required to withdraw and pay taxes on a small amount of the money from the IRA each year, leaving the rest to grow tax deferred for the rest of their lives if they wish!
The amount of money saved in the short term and the long term is staggering.
Now, in order to qualify for this “Inherited IRA” tax deferral plan, there are certain IRS requirements that they have to fulfill in order to make it work.
Next week, I’m going to outline the steps required by the IRS that your children and grandchildren have to follow perfectly in order to qualify.