Okay, maybe you have never wanted a new sports car—maybe you want a new, well, insert whatever that large ticket purchase you’ve always dreamed about into the sentence there. It doesn’t matter what that item is, we’ve probably all had those thoughts at some time, and your children likely have as well.
Perhaps during that daydream about making that purchase, you’ve pulled up your portfolio and looked at your bottom line. You say to yourself, “ah yes, I can afford it, I’ve got plenty of money in my retirement account.” Then you remember (or your financial advisor reminds you) that your retirement account consists of “qualified” (tax deferred) money; meaning—whatever you take out of the account will be treated as income and taxed accordingly to you. At that time, you make your decision accordingly.
Whatever decision you’ve made, you’ve made it after considering the income tax consequences. It’s your hard earned money. I find that people make better financial decisions when dealing with their own money (compared to decisions that some make when it comes to money they’ve inherited).
Now, to the main point…
Generally speaking, pensions are a thing of the past, and the most common retirement planning tools consist of various qualified retirement accounts. You (and if married, your spouse) are going to pass away at some point (sad, I know), and those you’ve named as beneficiaries on your qualified retirement accounts are now set to inherit (queue up slot machine jackpot music). Unfortunately, us human beings don’t always make the best financial decisions when grieving, so…
“I’ve always wanted a sports car. Dad always talked about them. I won’t get anything too extravagant, and he always bought ‘American made’ cars. I’ll get a Corvette!” Now the purchase has been completely justified. Son contacts the retirement plan company, quickly glances through the claim form and glosses over the income tax withholding section, signs on the dotted line, and the damage is done (an advisor, if there is one, will counsel against this, though that is sometimes futile).
At tax time the following year, son gets mail from the retirement plan company with “important tax documents enclosed” stamped on the front. Son finds out that after filing his tax return he owes the IRS a sizeable amount of money. “Man, the government sure knows how to stick it to ya…”
This, and many of the financial traps that inherited qualified retirement accounts present can, and should be avoided. Make sure these beneficiaries are aware of these traps. Concerned they don’t care? Plan around it!
It is very common for me to see families with the bulk of their assets in qualified retirement accounts. Planning to prevent a beneficiary from falling into this trap is easy. You can create a trust that is specifically designed to inherit qualified retirement proceeds, and direct your chosen trustee to distribute the funds to the beneficiary trust(s) as only you know best. You always have the option to set your beneficiaries up for success (or at least prevent failure).
Again, there are numerous issues that can arise when inheriting a qualified retirement account. My advice—discuss the plan for it with your attorney; discuss the process for inheriting it with your advisor; and, discuss the tax consequences with your CPA.
Off to the dealership, just kidding!
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