You know, this line is from Shakespeare’s Henry VI. The line is taken out of context of course. In fact, the speaker wishes to disturb law and order to become king. Killing lawyers and judges would disturb the order of society as they represented justice in that time.
I had my own reasons to take the line out of context. A question I received on my other site, JoeTaxpayer.com, in response to my article Inheriting or Bequeathing an IRA;
My father passed away last September leaving my then 10 year old daughter as his beneficiary and me as the contingent for his $300,000.00 IRA. The limited info that I get from the custodian of the account leads me to believe that an inherited IRA can be established for my daughter. Is this correct? I spoke to an attorney about this situation and was told that the government would not allow that and the the money would have to be withdrawn and placed in a savings account managed by a court appointed guardian. I would like the money to stay in an IRA so that the balance continues to grow.
I feel like I’m getting the run around.
First, a disclaimer. I quote Shakespeare and use hyperbole, I do not actually suggest that anyone kill any lawyers. I do suggest that any professional who in the course of their business gives advice that’s so incorrect it would cost a client not thousands, but potentially $100,000, that their license be revoked. Fined, and disbarred. Stop him before he costs other clients money.
Now, let’s look at the situation. An IRA is inherited via the beneficiary designation that’s part of the account held at a broker. It’s inherited by someone other than a spouse. The result is that the IRA title can change slightly, indicating the IRA is now a beneficiary IRA for the benefit of the named person. It can not get mingled with any other IRA, new deposits can’t be made to it, nor, under current rules, can it ever be converted to a Roth IRA. The 11 year old will have an RMD (a required minimum distribution) of 1/70.8 of the 12/31/11 value, in this case, $4237.29 if $300K was the year end value. The 1/70.8 comes from the IRS publication 590, where you look up the divisor to be used for that first year withdrawal. This is listed on Table 1 toward the back of the document. (For subsequent years the divisor drops by one, the form is not consulted again.) This is where I suggested that the Mom who asked me the question should ask the lawyer why this table, specifically to be used by beneficiaries of IRAs, would have the table reflect ages down to zero if there weren’t an option for lifetime distributions.
On a side note, say the funds are invested in an S&P index, and we are pessimistic, expecting 6% returns for the long term. 6% = 1/16.67 and it will take 54 years before this girl’s divisor drops to 16.8. Think about this. Her RMD will be less than 6% until she’s 65, the account will give off a bit of income each year but on average will grow until her RMDs exceed the growth in the account. If after withdrawals, the account grows just 4% each year, it will grow to $2.4 million by the time she’s 65.
Now, let’s look at the tax due. The first $1900 has a tax of $95 as a result of the kiddie tax (you can read more on that if you wish), but the remaining $2337 will be taxed at the parents’ rate, let’s say 25%. The child’s tax bill is $680 if there’s no other income involved. Now, let’s see the tax bill if Mom listened to the Lawyer. If the parents’ taxable income were $100K, their tax would be $17,060. Add $298,100K to this and for a taxable $398,100 (remember the kiddie tax) the bill jumps to $109,140 or a $91,415 bill for the $300K that gets taxed all at once. This is over a 30% average rate on the extra money vs 16% for the small sum each year.
To answer the second part of the lawyers bad advice, no, a “court appointed guardian” isn’t required. We are not talking about an orphan here, a parent is a child’s legal guardian, and can serve as custodian of brokerage accounts until the age of majority in their state, 18 or 21. To make matters more simple, an inherited IRA avoids probate. It can be retitled upon showing the current custodian the death certificate and identification of the beneficiary. If the lawyer offering what amount to some pretty horrific advice is reading, let me suggest that when a client ask you about IRAs, you tell then the truth, “I don’t know.” Because you don’t. I understand you will not refer them to me, I take no offense. What you might want to do is offer them a copy of any of Ed Slott’s recent books. I gave away copies of Ed’s The Retirement Savings Time Bomb when Rothmania launched. You might want to pick up a copy yourself.
Unfortunately, I don’t know how many people are getting this kind of bad advise, I just know it’s all too common. Fortunately, I was contacted before a bad mistake was made, too often I hear these stories well after the fact. People go to a pro thinking they are doing the right thing, only to find out the pro is shall we say, uninformed.
Please keep those questions coming, and if you have a friend in this kind of situation, remember, “Friends don’t let friends destroy their inherited IRAs.”