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As most of my clients are aware, the management of retirement accounts and subsequent distributions represent the largest facet of my practice. Over the years as many clients have changed jobs, retired, or simply had a need to access retirement funds, I have successfully guided them to avoid missteps that might seriously derail their retirement income strategy. The following discussion will identify some of the mistakes I have experienced and the methods that may be taken to sidestep them.

One of the most disastrous errors I have witnessed is the transfer of employer sponsored retirement plans to an IRA. There are two methods to direct these account into an IRA: a direct transfer from the plan to the IRA or a distribution to the account holder who then forwards it to the IRA. If the account is sent directly from the plan to the IRA, no taxes are withheld. But if the account holder decides to receive the distribution first and then move it to the IRA, the plan administrator is required to withhold 20% of the account value for federal income taxes. For a large distribution, this tax withholding represents a significant drain. Even if the intent of the account holder is to subsequently transfer the distribution to an IRA, taxes must be withheld. They can only be recouped after the account holder files their income tax return which might not occur until much later in the year. Furthermore, if only the net distribution is rolled over into an IRA, the 20% withholding is deemed a distribution and thus subject to tax. As a result, personal funds may be necessary to fund this shortage in order to rollover the full distribution and avoid all taxes. This action might result in a major cash flow problem. To avoid this pitfall, the optimal transfer method is to directly transfer the account to the IRA.

Another common mistake occurs when attempting to consolidate several IRAs into one for simplification and management purposes. Instead of authorizing a transfer directly from one custodian to the other, the account holder may decide to expedite this process by liquidating the account and have the proceeds sent directly to them. When an investor liquidates an IRA, they may repay it within 60 days to avoid it being deemed a distribution and thus taxable. However, beginning January 1, 2015 only one such indirect rollover is allowed within a 12 month period. If multiple IRAs are liquidated during this time frame, a 6% penalty on the value of transferred assets of more than one account will be imposed.

Under current law, the only time an IRA from a deceased account holder can remain intact as an IRA is if the beneficiary is the surviving spouse. Upon the death of an IRA account holder, many advisers automatically re-register the account to the surviving spouse as an IRA. However, if the IRA represents the main source of income for the surviving spouse and that spouse is younger than age 59½, any subsequent distributions from the IRA will result in a 10% penalty. Instead, the optimal solution to avoid the penalty is to re-register the IRA as an IRA beneficiary account where distributions are subject to only income taxes with no penalties.

When designing an estate plan, perhaps the most repeated oversight I have experienced is the failure to periodically review and update beneficiaries on retirement accounts. Over the years, I have scrutinized retirement accounts where the primary beneficiary is deceased or a divorced spouse has not been removed. There are two beneficiary designations that should almost never be used - the estate and minor children or those with issues. By naming the estate as beneficiary, you convert a non-probatable asset to probate as well as limit your ability to "stretch" the IRA for individuals. And naming minor or challenged children may result in a court appointment of an administrator who may distribute the account contrary to the wishes of the deceased account holder.

As many of my clients attain age 70½, they are required to withdraw funds based upon a calculation of the required minimum distribution (RMD). The formula to ascertain the RMD is based upon two factors: the value of all individually registered retirement accounts (there are exceptions for individuals who continue to work, are older than age 70½, and who maintain a retirement account in their employer sponsored plan) and the life expectancy percentage as provided by the IRS. If the RMD is not satisfied, a 50% penalty is imposed on the shortage. While IRA custodians will notify account holders of the RMD for the account for which they hold assets, it is highly unlikely that they are aware of the existence of other retirement accounts. Unfortunately, I have experienced situations where individuals failed to aggregate all of their retirement accounts for calculation purposes and thus did not meet their RMD. This oversight will likely result in the aforementioned 50% penalty. Please note that it does not matter where the RMD is withdrawn as long as the distribution is based on the value of all retirement accounts.

In summary, an almost universal rule of thumb to avoid problems and penalties on the movement of retirement accounts is to implement a trustee to trustee transfer. Also, beneficiary designations need to be examined to ensure that estate planning objectives are met. Finally, management of the RMD is essential to minimize taxes and avoid penalties. For many individuals where their retirement account may represent their largest asset, failure to properly monitor and manage this account can result in disastrous consequences for both the account holder and their beneficiaries.


Clifford L. Caplan, CFP®, AIF®