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Ten Key IRA Planning Mistakes

Knowing what missteps to avoid and why will keep your clients financially healthy.

By Bruce Harrington

Your clients have been contributing to their IRAs for years, possibly decades. They are taking full advantage of their tax-favored accounts and are well on their way to long, comfortable retirements. Or are they?

As an investment advisor, you want to help your clients prepare for their golden years in the best way possible. With that in mind, here are 10 IRA planning mistakes that many investors make. The next time you meet with your IRA clients, run down this list because knowing what to avoid and why can help you ensure that your clients’ investments are on the right track.

Be sure to let your clients know that separate IRAs may be established for spouses with little or no income.

10. Making inappropriate spousal rollovers
Oftentimes, spousal beneficiaries will roll an IRA into their own IRA. Your clients will benefit from your informing them it’s often more tax efficient to leave it in the original owner’s name. For instance, if the spouse beneficiary is under 59-and-a-half, he may want to leave the assets in a “Beneficiary IRA” to allow him to take distributions free of the 10 percent premature-distribution penalty that would apply if he took distributions after the account was rolled over into the survivor’s name.

9. Assuming a nonworking spouse cannot contribute to an IRA
Be sure to let your clients know that separate IRAs may be established for spouses with little or no income and those additional retirement savings can add up over time. Even if the working spouse is covered under a retirement plan at work, the contribution on behalf of the non-working spouse may be fully deductible as long as the couple’s adjusted gross income is below $150,000 for the year.

8. Skipping additional “catch-up” contributions
Remind clients over 50 that they should not forget IRA “catch-up” contributions, currently set at a maximum of $500 annually and increasing to $1,000 in 2006. They should also know that most plans allow for catch-ups of an additional $3,000 this year, increasing to $4,000 in 2005 and $5,000 in 2006.

7. Beneficiaries not taking advantage of IRD
IRAs are considered “Income with Respect to a Decedent” (IRD) and your clients should be advised that beneficiaries can take an income-tax deduction for any estate taxes they paid on the IRA. Tax code 691(c) provides relief from double taxation for recipients of IRD in the form of an income-tax deduction equal to the estate taxes paid on the IRD.

6. Placing the title of the IRA into a trust
Changing the actual ownership of the IRA to a trust causes immediate taxation. Tell your clients to simply name the trust as the IRA beneficiary. Also, confirm that using the trust as the beneficiary is really necessary. Individuals have been known to name trusts as their beneficiary even when leaving assets outright to a beneficiary may have provided a better outcome over the long term.

5. Taking the wrong RMD
Analyze the new rules regarding required minimum distributions (RMDs) and avoid taking out too much or too little—and getting taxed. A 50 percent penalty applies to any RMD not taken in a timely fashion. A larger penalty like this is an excellent reason to get your clients to consolidate all their retirement accounts and ensure that no distributions are missed.

4. Missing important dates
Do you know why December 31 or September 30 of the year following the year of an IRA owner’s death is important? Cash-out and distribution rules are vital to remember. As mentioned earlier, a stiff 50 percent penalty applies to distributions not taken in a timely fashion. Remind beneficiaries that any RMD due to the deceased in the year of death must be taken by December 31 of that year.

3. Not taking advantage of increased contribution limits
In 2002, contribution limits for IRAs increased from $2,000 to $3,000— the first increase in 20 years. This limit is set to increase to $4,000 in 2005. Many clients may not be aware of this update.

2. Not listing beneficiaries or not updating IRA beneficiaries
Avoid distribution of the IRA assets to the owners’ estate by listing beneficiaries, updating designations and coordinating them with estate planning documents. Having distributions made to an estate could forfeit dozens of years of potential tax deferral for beneficiaries.

1. Not taking advantage of the stretch distribution option or not establishing it properly
The “Stretch IRA” allows nonspouse beneficiaries to maximize payouts over their life expectancy—if they know how it works. This plan can also allow nonspouse beneficiaries to extend distributions from the account over their own lifetimes, after the owner’s death.

Bruce Harrington is vice president, director of product development and marketing and product manager of all MFS Investment Management's 529 college savings plans and retail retirement products. For more information, call MFS at 1-866-MFS-PLAN.

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