Preventing surprises for your IRA beneficiaries
By Cora M. Barnhart • Bankrate.com

Choices you make today concerning IRA distributions will affect your beneficiaries for years to come. Unfortunately, many distribution recipients have unintentionally committed slip-ups that will impose substantial income tax liability on future inheritors.

This tax tip addresses measures you can take today that will prevent basic distribution mistakes. One of the most important ways to protect yourself is to fill out, file and keep a copy of a beneficiary form. Following the tips presented here can prevent many tax problems associated with inheriting an IRA.

Complete and file a beneficiary form
Here are five steps you can follow today to avoid mistakes in your IRA distributions.

(Based on "Oops ... How a Variety of Basic Foul-Ups Are Bedeviling the Beneficiaries of IRA's" by Lynn Asinof. Published March 29, 1999, in The Wall Street Journal)

Step 1: File a beneficiary form with your provider.
Step 2: Check the information on the beneficiary form for accuracy.
Step 3: Keep a copy of your beneficiary form and notify your family of its location.
Step 4: Find out how your provider calculates minimum distributions.
Step 5: Review your beneficiary form to determine whether is addresses extenuating circumstances.

The article cited above shares several horror stories regarding distributions to inheritors. The first way to you can avoid basic distribution mistakes is to make sure you actually have a beneficiary form on file with your IRA provider. This applies even if you completed one years ago. It may no longer be on file, and as the following cases verify, the mistake won't be discovered until it is too late.

In one case, a $95,000 IRA inherited by the holder's daughter must be distributed within five years because the bank can't find the beneficiary form. The daughter will owe substantial taxes. With the form, the IRA could have grown tax-deferred over the daughter's life expectancy. Why does this matter? If the IRA earned an annual return of 10 percent per year and the daughter were to take only minimum distributions over her life expectancy, the woman would have received at least $1.5 million after taxes.

According to New York tax attorney Seymour Goldberg, misplaced beneficiary forms aren't unusual. A major New York bank lost the beneficiary forms from several recently acquired banks. This forced four of his clients to inherit IRA's without the tax-deferred compounding benefit.

Besides filing the form, you also need to make sure the information is accurate. Faulty information like an erroneous birth date results in incorrect distribution calculations, warns The Wall Street Journal. You should keep a copy of this form, and inform your family members where you will keep it.

Calculation of minimum annual distributions
IRA holders are required to take distributions by April 1 on the year after they become 70-^1/₂. Determining the minimum amount you can remove from your IRA without getting in trouble with the IRS isn't easy. Many IRA holders rely on their IRA providers to steer them in the right direction, but they could be making a serious mistake. In a review of 194 clients receiving IRA distributions determined by their providers, Cleveland financial adviser Tama McAleese has found mistakes in at least one-third of the cases.

Find out how your IRA provider calculates minimum distributions when IRA holders don't provide necessary information. The method selected can substantially decrease the money remaining in the account for the holder and the heirs. Many providers rely on the recalculation method to determine the minimum distribution. This information is available in tables provided by IRS Publication 590: Individual Retirement Accounts.

As indicated in related tax tips, many IRA holders don't realize there is an alternative to using these tables. According to an article by Greg Kolojesky, the IRS actually accepts two methods for determining life expectancy. The Recalculation Method estimates life expectancy for Tables I and II in IRS Publication 590: Individual Retirement Arrangements. An alternative method, the Term Certain Method, starts with a life expectancy from this table, but the value decreases 1.0 for each year.

What's the difference between the two methods? According to Kolojesky, the Recalculation Method results in longer life expectancies. Remember that the actual distribution from your IRA can always exceed the Required Minimum Distribution.

While the Recalculation Method minimizes distributions, there is a drawback to using this method. Life expectancy under this method becomes zero when the person for whom it is used dies, forcing the IRA to be distributed in the next year. Death doesn't affect the life expectancy calculated under the Term Certain Method. So IRA holders naming spouses as beneficiaries may further minimize their distributions by using the Recalculation Method for their life expectancy and the Term Certain Method for their spouse.

Check your IRA provider's beneficiary form
So, you've copied that form you just completed and filed. You've notified your family where you keep the copy. And this was after you learned everything you could about calculating that minimum distribution from using alternative life expectancies. There's nothing else to worry about, is there?

The Wall Street Journal advises against relaxing just yet. Check your beneficiary form to see whether complications such as multiple beneficiaries or a beneficiary's death are addressed. Some forms don't even permit you to choose how your distribution will be calculated. The sooner you check this form, the more time you will have to decide how to handle these matters. What you don't want to do is to put yourself in a position where someone else is making these decisions for you.

Conclusion
Choices made today regarding IRA distributions can affect your beneficiaries for years to come. Unfortunately, many of these choices result in slip-ups that are imposing substantial income tax liability on future inheritors.

This tax tip addresses measures you can take today that will prevent basic distribution mistakes. One of the most important ways to protect yourself is to fill out, file, and keep a copy of a beneficiary form. Following these tips can prevent many tax problems associated with inheriting an IRA.

--Nov. 1, 1999