Many investors want to leave assets to their heirs, be it children or grandchildren or others. Among a list of assets that one has to leave to others is often an IRA (Individual Retirement Account), and while it is a very kind gesture to leave your IRA to family, this topic can be complex and there are right ways to do it and many wrong ways.
One of our readers shared a story of how she inherited an IRA from her recently deceased mother and as it turns out, this is a prime example of how not to leave a retirement account to a family member.
“My mother named me and my siblings as beneficiaries to her IRA and her verbal intentions was that we use the money for the educational expenses of her very young grandchildren, shared Audrey (not her real name). None of us were deeply involved in her finances, and given that she was in her mid-70’s, did not give much thought to her kind gesture and assumed she had many more years to live”
Sadly, Audrey’s mother passed away after a sudden illness and she and her siblings were inheriting assets, including the IRA. This became a classic case of what not to do with an IRA because the intentions were to help with college funding, but the investments were still in an IRA at the time of her death, and in the absence of a trust the only way for the funds to get to the kids was for them each to inherit a portion of the IRA, meaning each inheritor now had an additional IRA. If they want to now use that money for education funding, they must take distributions and pay taxes at their current rate, which is much higher than the rate their mother would have paid, given she was retired.
So, what should have Audrey’s mother done in retrospect? First, she should have had a financial advisor guide her through not only retirement planning, but estate planning given her specific wishes for the money.
Second, there are many options available to optimize an IRA that is going to be left to family and these should be discussed with a qualified advisor to decide which is best for an investor. A conversion from a traditional to a Roth IRA can make sense for many given heirs won’t have to pay income taxes on the proceeds. Of course, Audrey’s mother she could have taken her distributions and been taxed at the lower rate as we discussed. Another tactic would have been to leave the IRA to her husband, and he could then grant that money to his kids at the lower tax rate given he too is retired.
There are many lessons to be learned here. It is wise to annually review your estate plans, using a qualified financial advisor and sharing your full intentions with both your advisor and family so that final wishes can be fully followed without needless loss.
MyPerfectFinancialAdvisor is the premier matchmaker between investors and advisors using personalized data, proprietary algorithms, and deep industry experience.