6 costly IRA mistakes physicians should never make

November 18, 2016

By Doug Bowden

With more than $7.2 trillion invested in Americans’ IRAs1, chances are you have taken advantage of this popular savings mechanism. In fact, more than 65 percent of physicians have made contributions to in Individual Retirement Accounts (IRAs) in addition to their qualified retirement plans, according to the 2016 Report on U.S. Physicians’ Financial Preparedness, recently released by AMA Insurance. 

IRAs are popular because they allow you to contribute pre-tax dollars and grow your money tax-deferred. But without the proper precautions, you can easily lose the tax-saving benefits of your hard-earned money. Make sure your savings are protected for your retirement and family inheritance by avoiding these costly—and all-too-common—mistakes. 

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Excerpt from 2016 Report on U.S. Physicians Financial Preparedness
@AMA Insurance Agency, Inc., a subsidiary of the American Medical Association.
See the 2016 Report for more differences in physicians by age.

While IRAs are good for saving for retirement, they are a source of tax revenue for the federal government, which would prefer that individuals not defer taxation. Thus, the government has imposed Required Minimum Distributions (RMD) amounts IRA owners must take out of their IRA beginning at 70.5 years of age. 2

Here are six common mistakes—and ways to avoid them—that I shared with physicians as a speaker at the recent Physicians Financial Partners Summit:

1. Forgetting to take your RMDs beginning at age 70 1/2.
This is a very common mistake—and it’s quite costly if you don’t take those distributions.  

If you forget to take an RMD, the government can assess a 50 percent penalty on what that RMD would have been. Plus, that money will be taxed as ordinary income again when you take it out of that IRA.  

So you could pay 70 percent tax on the amount you take out of that IRA if you miss the RMD. It’s very important to be on time.

2. Failing to stretch IRA distributions for tax effectiveness. 
Physicians who don’t have an immediate use for their IRA funds at retirement should consider using a stretch IRA strategy to transfer this wealth more cost-effectively to the next generation. 

Beneficiaries who cash in IRAs when they inherit them will pay income tax upfront. However, if they instead take smaller distributions each year, they can build up the IRA’s value by keeping it going. That means the tax deferral will continue as the money grows in the IRA until the beneficiary needs the funds years down the line.

Take note: Since 2012, the federal government has been looking at IRAs as a significant tax opportunity. “Stretching” IRAs is something the government has considered eliminating.

In other words, upon your death, the IRA would be subject to accelerated distributions—and tax payments—over five years for non-spouse beneficiaries. 

3. Failing to maximize the IRA transfer to the next generation. 
If you have earmarked your IRA for your heirs, you should establish an asset repositioning plan to transfer that value most efficiently. For example, you can take part of the RMD and fund a life insurance policy. That way, your IRA continues to the next generation, plus an additional death benefit will be paid out. 

Insurance can be used as a planning tool to minimize taxes paid on your IRA assets and maximize the legacy to your heirs, while giving you protection and control.

Tip: Learn more about how you can reposition your IRA assets to maximize your legacy and control. Experts can help you establish the best IRA maximization strategy for you.

4. Incorrectly naming a beneficiary. 
Many people don’t sufficiently follow through with the required paperwork to ensure their IRA funds will be protected from higher taxation. 

For instance, many people forget to finish the correct paperwork when they roll over a 401(k) or 403(b) into an IRA. Many investors also forget to correctly update their beneficiaries when they go through life changes, such as divorce or remarriage. 

If you don’t have a beneficiary named, your IRA funds will become part of your estate upon your death. In that case, the government can force accelerated distributions over five years in order to collect the taxes at the higher estate rate.

5. Not naming a successor beneficiary
On the other side of the fence, when a beneficiary inherits an IRA, they often forget to name a successor beneficiary. This is very important. If the beneficiary dies, once again the IRA has to be disbursed within five years. 

But if a successor beneficiary has been named, that beneficiary can simply continue to take a lifetime of RMDs, save the taxes, and get more out of the IRA as life goes on. 

6. Designating the wrong type of trust as the beneficiary. 
People often name a trust as their beneficiary. But you need to be careful to do that the correct way.

Only a look-through style trust—one that is clearly linked to a real person or people in the background of the trust—will work. If you don’t establish a look-through trust, the trustee will be required to accelerate all payments from the trust over a five-year period upon your death. If the trust is in a really high tax bracket, any income over $13,000 will be taxed at the highest possible income tax rate: a hefty 39.6 percent.

What a look-through trust does is base the RMDs on the age of the oldest beneficiary inside the trust, which keeps the IRA (and the tax deferral) going. Trusts are commonly used for estate planning and wealth transfer purposes, but you should take special caution in how you set them up.

If you want to leave your IRA assets to the next generation, have the important conversations now: Talk to your financial advisor and your family about these issues, and explore strategies that can work for your situation.

About Doug Bowden

Doug Bowden, CLU, ChFC, is director of advance markets for Symetra Life Insurance Company, where he handles complex case designs involving executive benefits, wealth preservation, life insurance, and charitable planning. This article is an excerpt of his educational presentation to physicians during the Physicians Financial Partners Summit in May.

Symetra Life Insurance Company is headquartered at 777 108th Avenue, NE, Suite 1200, Bellevue WA 98004-5135.

This material is not intended to provide investment, tax or legal advice. Clients should consult their attorney or tax advisor for more information.

1Source: ICI (Investment Company Institute), “Appendix: Additional Data on IRA Ownership in 2013,” ICI Research Perspective, Vol. 19, No. 11A, November 2013.

2Required Minimum Distributions (RMDs) apply to qualified assets and must begin at age 70 ½. RMDs are calculated using life expectancies based on the IRS Uniform Lifetime Table and the recipient’s age at the beginning of each year.

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