Naming a beneficiary for your traditional Individual Retirement Account (IRA) need not be a difficult task. Most people choose their spouse, if married, or another loved one. However, the rules governing the distribution of IRA assets to beneficiaries are not so simple. With this in mind, here is a quick look at the Internal Revenue Service (IRS) rules for inherited IRAs.

Taking a Closer Look

The IRS stipulates that an IRA owner must begin taking required minimum distributions (RMDs) by April 1st of the year following the calendar year during which he or she reaches age 70½, commonly referred to as the "required begin ning date." IRA beneficiary rules involve two separate issues:

1. the age of the IRA owner at the time of death; and
   
2. the identity of the IRA beneficiary (the rules for spousal beneficiaries differ from those for non-spousal beneficiaries).
   

Spousal Benefiaries

If an IRA owner dies before RMDs have begun, a spousal beneficiary can choose to withdraw all IRA assets within five years, maintain the IRA under the deceased spouse’s name, or treat the IRA as his or her own. Suppose Jim Bradshaw (a hypothetical case) dies and his wife, Linda, is the beneficiary of his IRA. If Linda maintains the IRA in Jim’s name, minimum distributions do not have to begin until December 31st of the later of:

1. the year following the year of Jim’s death; or
   
2. the year in which Jim would have reached age 70½.
   

However, distributions would be based on Linda’s life expectancy. If Linda chooses to treat the IRA as her own, she is entitled to name new beneficiaries, and the rules governing RMDs would be the same as if the IRA were originally her own. Therefore, distributions would have to begin by April 1st of the year after the year in which she turns 70½, and the required amount would be based on her life expectancy.

If Jim were to die after RMDs had begun, the options for Linda would be different. She could choose to either continue receiving distributions based on Jim’s life expectancy, or her own life expectancy. As a third option, Linda could opt to roll over Jim’s assets into her own IRA. (This option is not available for IRAs that have been annuitized.)

Non-Spousal Benenficiaries

Non-spousal beneficiaries have fewer options than spouses. Unlike spousal beneficiaries, non-spousal beneficiaries may not treat IRAs as their own, and cannot name additional beneficiaries. If the owner dies before the required beginning date, all assets in the account must be distributed by the end of the fifth anniversary year of the owner’s death. Alternately, the beneficiary may elect to receive distributions over his or her life expectancy. The amount of distributions is based on the beneficiary’s life expectancy, and must begin by December 31st of the calendar year immediately following the calendar year of the owner’s death.

If the owner dies on or after the required beginning date, the assets must be distributed over a period not exceeding the larger of the owner’s or the beneficiary’s life expectancy.

Parting Thoughts

Under regulations proposed by the IRS in 2001, and finalized in 2002, beneficiaries may be named as late as September 30th of the year after the IRA owner’s death. Furthermore, a primary beneficiary can disclaim an inheritance, allowing it to pass to a contingent beneficiary. In response to the increased longevity of the American population, the IRS has increased life expectancy figures, which essentially reduces required distributions.

If you are an IRA owner or beneficiary, the wide variety of beneficiary arrangements can easily lead to confusion. It is important to be aware of your options and the tax consequences that may apply in your situation.$

It’s easy to underestimate your net worth. After all, without a crystal ball, the future value of your home and savings is hypothetical. What’s not hypothetical, however, is the fixed amount of the death benefit provided by your life insurance policy. Adding this often significant sum to your asset pool could expose your estate to the federal estate tax that can run as high as 46% in 2006. Fortunately, there are trusts that can exclude life insurance from an estate.

Many people assume that because death benefit proceeds from a life insurance policy are generally not considered taxable income to the beneficiary, a life insurance policy is out of the reach of the Internal Revenue Service (IRS). However, when the policy’s death benefits are added to the appreciated value of your home and savings, it may come as a shock to find that the value of your estate may exceed the $2,000,000 applicable exclusion amount for 2006 (scheduled to rise gradually to $3.5 million by 2009 based on the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA)).

Taxpayers should be aware that federal estate taxes are scheduled for full repeal in 2010. However, EGTRRA contains a “sunset” provision, whereby all provisions automatically expire in 2011, effectively reinstating the prior levies unless Congress acts in the interim.

Although the unlimited marital deduction allows spouses to transfer assets between them without assessment of estate taxes, nonspousal heirs face the possibility of seeing a life insurance policy inflate an estate’s value past the scheduled exemption amount in the year of death.

One Strategy: A Credit-Shelter Trust

One way to get the life insurance policy out of your estate is to use a type of bypass trust known as a credit-shelter trust. Essentially, a trust is a legal contract between a named donor, a managing trustee, and a beneficiary.

For estate conservation purposes, a trust could be set up to maximize each spouse’s applicable exclusion amount, perhaps sheltering more assets from estate taxation than may be possible through use of just the unlimited marital deduction. At the death of one spouse, an amount equal to his or her applicable exclusion amount could pass to a trust to benefit the surviving spouse, with the remainder of the assets passing outright to the spouse. Then, at the death of the surviving spouse, assets in the credit-shelter trust could be paid to the couple’s children—without being subject to federal estate tax. Any assets outside the trust upon the surviving spouse’s death, and therefore potentially subject to estate tax, could be further sheltered by the second spouse’s applicable exclusion amount for that year.

Another Approach: An ILIT

When children are the beneficiaries of a life insurance policy, and the owner wants to exempt the policy from the estate’s total worth, an irrevocable life insurance trust (ILIT) is another approach. Keep in mind, however, the term "irrevocable" means beneficiaries may not be changed and loans may not be paid out from the policy once it is put into the trust. Putting a hefty life insurance policy into such a trust could help beneficiaries finance the purchase of a family business or pay estate taxes. However, funding an ILIT may result in gift taxes due.

Park Your Policy in the Right Spot

A trust, depending on the type, can help reduce or defer taxes on high-value assets such as a life insurance policy. More broadly, a trust can be the means to help ensure the policy’s benefits go directly to the intended beneficiary. With the flexibility of trusts, however, comes complexity. It is always best to consult with an estate attorney who is experienced in tax matters before proceeding.$

When can I take money out of my 401(k) account without penalty?

A: You can take money out of your 401(k) account without incurring a 10% penalty if you’re older than age 59½, if you take a loan from your 401(k) account, or under limited circumstances outlined in the Tax Code. However, income taxes are due with any withdrawal (not loan) from a 401(k) account.

Q: What are some of the limitations typically placed on borrowing from a 401(k)?

A: Many 401(k) plans allow participants to borrow from their respective accounts. Generally speaking, 401(k) plan loans cannot exceed the lesser of $50,000 or 50% of your vested account balance. The minimum amount you can borrow depends on the plan. However, by law, the plan cannot set a loan minimum that exceeds $1,000.

Q: Is borrowing from a 401(k) a good idea?

A: That depends on your specific situation. Generally speaking, your 401(k) account should only be considered as a source of funds after all other options have been explored. Keep in mind, whether you withdraw or borrow from your 401(k), you may be defeating the original purpose and benefits of such a plan—that is, saving for your retirement.$

Prospective insurance buyers are often confused about disability income insurance because the features and benefits vary widely from one policy to another. Essentially, there are a few key elements that could make a big difference when you make your choice. If you are in the market for disability income insurance, here are some of the things you should consider:

Definition of "Total Disability." Does the policy define total disability as a condition during which you cannot perform the duties of your "own occupation" or "any occupation"? A policy that refers to your "own occupation" generally pays benefits if you cannot return to work in your own field, or if you return to work in a lower paying job, or a job in another occupation. A policy that refers to "any occupation" generally would pay benefits only if you were unable to perform any job, either your own, a lower paying job, or a job in a new occupation.

Duration of Benefits. Even if you have to choose a smaller benefit amount to keep the premiums affordable, look for coverage that protects you until age 65. Note: There are policies available that offer benefits only for a limited period, for example, a maximum of two or five years, and the nature of your occupation may affect the duration of coverage.

Amount of Coverage. Most plans set a limit on the percentage of income you can insure—usually 50% to 60% of your total gross earnings. If you have an employer-provided plan that offers only limited group coverage, you may consider buying supplemental, individual disability income coverage.

Elimination Period. The waiting or "elimination" period is the amount of time you must wait before disability benefits can start. Remember, shorter waiting periods involve higher premiums and vice versa. In addition, the waiting period is determined when a policy is issued, not when disability commences.

Taxation of Benefits. Benefits may be tax free if you pay the premiums using after-tax dollars. Benefits under most employer provided plans are taxable because they are usually paid with pre-tax dollars (although it may be wise to verify this with your tax professional).

Partial or "Residual" Coverage. After a serious disability, many people are able to return to work only on a part-time basis. Partial or "residual" benefits allow you to receive partial disability benefits, as well as your part-time income, until you fully recover. Without this feature, your benefits may stop as soon as you return to work.

Portable Coverage. Policies that allow you to carry your coverage from one job to another have an obvious advantage. Coverage from a professional association could be one such example of portable coverage that is not tied to your place of employment, not to mention any individual disability income policy that you might buy on your own.

Of course, prior to shopping for a policy that best suits you, it is important to determine the right amount of coverage you need in light of what coverage you may or may not already have. Therefore, make it a point to review your insurance coverage and needs on a regular basis in order to ensure you are adequately protected.$