Apr 28

I recently became aware of a situation that was pretty upsetting, even though it happened to someone I don’t know and never met. A friend of a friend passed away and left her brother a sum of money in a trust. The brother, disabled, and not working, panicked, and took the money out. Now, when I first heard this, I thought that since it was in a trust, he may have some capital gains due, but that should be minimal. What happened was that the trust held the deceased woman’s IRA, so every last cent was taxed as ordinary income. Even though he had no other income, his tax bill was well over $40,000. A peek at Fairmark tells me that in 2008, one can have $8950 income not be taxed at all (this figure is the sum of the single exemption and standard deduction). The next $8025 is taxed at 10%. So this poor soul could have withdrawn $16,975, rising a few hundred each year, and paid about $800 in tax. The interest alone on the $40,000 would pay his taxes each year. It’s unfortunate that he started asking for advice well after the withdrawal was made, as he could have rolled this money into a beneficiary IRA within 60 days of the withdrawal.

The lesson here, when a loved one passes away, take a breath, don’t panic. Mourn, and take some time. Ask questions and understand where the money, stock, real estate is, before making any decisions you are likely to regret. I hope you can learn from this person’s mistake.

Joe

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10 Responses to “On my Death, Please, Take a Breath”

  1. JAL Says:

    Joe,

    In a retirement planning book I read recently, the author related a story of a young man who inherited a sizable IRA from someone other than his spouse, and he managed to somehow roll it into his own existing IRA at another brokerage or bank. He didn’t know any better and presumably was acting without bothering to read any of the handy IRS publications available or without seeking expert tax planning advice. I realize “roll” is not the correct technical term for what he did with the money.

    This transaction wasn’t caught for some number of years until an alert financial planner at a brokerage firm he later transferred his IRA to noticed the mistake made earlier and dutifully reported it to the IRS.

    The young man not only had to pay regular income taxes and the 10% early IRA withdrawal penalty, he also had to pay additional penalties and interest for failing to report the withdrawal in the year it occured.

    Needless to say it was very very expensive and painful mistake… effectively decimating the inherited IRA.

    Regards,

    JAL

  2. JOE Says:

    I will work on an article for my May main web post describing the method used for inherited IRA. Thank-you for pointing out that risk.
    Joe

  3. Rachel @ Master Your Card Says:

    I would certainly seek professional advise on this one. I know that in the UK, if you inherit anything you have to pay inheritance tax and there are ways to get around this legally but it is important to check things out before you risk breaking the law.

  4. JOE Says:

    Rachel, it’s always good to get professional advice and not rely on the kindness of bloggers. But – most people don’t know they are about to make a mistake, the opening of the IRA (Which you know is a retirement account) is an every day occurrence, and the initial account is often opened with a thousand dollars or less. In this case, my warning is to help them at least get the initial set up correct, have the beneficiary details set up to avoid a problem down the road. Also, in the States, the tax is paid by the estate of the deceased, not the beneficiary. Again, it’s the IRA that causes confusion, as the money passes with no tax if done right, but is then taxed upon withdrawal. Thanks, again, for visiting.
    Joe

  5. * How To Avoid Inheritance Tax Says:

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  6. Kelly Says:

    Excellent advice, Joe!

  7. Bralyn Says:

    Can someone put in a will that they want you to be a beneficiary on their life insurance policy but not change it? I think this is what someone did and not sure what to do here. Person has passed away within two weeks ago and although policy is small, would need policy to bury him. Other beneficiary was old flame from 30 years ago. Will I have any rights? Other people heard him say he wanted to change this but what good will this be. Thanks.

  8. JOE Says:

    No. Retirement accounts and life insurance need named beneficiaries. That said, if the deceased owned his own policy, with no beneficiary, the insurance goes back to his estate and would be distributed via will.

  9. Leah OHearn Says:

    I am the beneficiary of my husband’s (2) IRAs. This is our 2nd marriage each. I wish to leave the IRAs to my son, should we die simultaneously. Would I designate that in my Will?

    I don’t believe my husband would be willing to have my son’s name on the IRA as a contingent beneficiary. He was reluctant to leave anything to me.

  10. Joe Says:

    No!
    The best way to leave any qualified plan is via designated beneficiary designation on the account itself. Hubby as 100% primary, if that’s what you wish, and son 100% contingent beneficiary. And you should leave a note, or better yet, have a conversation with your son, explaining that this money can be taken over his lifetime when you pass. If it’s all pretax, he’ll minimize his tax bill by taking out a small amount each year, the RMD for a beneficiary.

    Who is hubby’s contingent beneficiary? If he has no children of his own and doesn’t have any animosity to your son, why wouldn’t he make him contingent? If he wants your son left out, he should choose a charity or a friend, either way, I’d have a contingent listed.

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