by Archie M. Richards, Jr., CFP^®
April 24, 2006

It's easy to make mistakes with the inheritance of traditional IRAs that can cost unnecessary taxes and lost earnings. But don't take this column as the last word; get help. One good source of advice is Vanguard's Retirement Department (800-523-7731).

If you die before April 1 following the year you attain 70½, your IRA must be distributed by the end of the 5th year following the year of death. (Don'tcha just love tax language?) During those 5 years, no distributions are required. But if the account is large enough, the withdrawals must pay tax at the maximum 35 percent federal rate. To save beneficiary taxes, try to die on or after April 1 following the year you attain 70½.

If you survive to that date, prevent the IRA from becoming owned by your estate. That's what happens if you name no beneficiaries. Those who inherit an IRA from your estate must continue the relatively high distributions based on your life expectancy at death. This makes their required distributions larger, costing them extra taxes.

Many people name their spouse as primary beneficiary. In event the spouse dies first, also name secondary beneficiaries. If those are to be your children, write "my descendants by the branch." This enables each family group to receive equal shares.

If you divorce and remarry, prevent bitter conflict. Change the name of your spousal beneficiary, and do it pronto.

After the original owner's death, the surviving spouse can re-title the IRA into her own name or transfer the funds to her own IRA. In either case, she should specify the beneficiaries whom she wants to inherit after her death. As long as they're younger, their life expectancy is longer. This makes their required distributions after your death lower, saving taxes for them. Smaller distributions also mean that more remains in the IRA to continue growing in a tax-deferred environment.

Non-spousal beneficiaries cannot transfer the IRA into their own names. But they can, and probably should, change the IRA's name to, for example, "IRA of Sally Smith, deceased, for the benefit of son Sam."

Sam is younger than his mother, of course, making his required distributions lower than hers and again saving taxes.

Anyone who's short of cash and doesn't mind the higher taxes can of course take out more than the required minimums. The government won't mind the additional revenues.

If several non-spousal beneficiaries inherit as a class, they should probably split the IRA into separate shares. If this is not done, the minimum withdrawals are based on the life expectancy of the oldest heir. That person would have the group's shortest life expectancy, making the required withdrawals larger for the others.

A properly-drafted living trust can also be made the beneficiary of an IRA. Living trusts have many advantages, although an IRA held in a trust cannot be split into separate shares.

All these requirements (I've barely touched the surface) are utter nonsense. IRS Publication 590, which describes IRA rules (www.irs.gov/pub/irs-pdf/p590.pdf), is 104 pages of tough reading. To raise government revenues, not a word of it is necessary. IRAs are leading tax loopholes. Congress should instead assess a low, flat tax rate on all income, with no loopholes. The cost of keeping track of the millions of complexities in the tax code is almost as high as the actual taxes paid - a gargantuan waste of time and effort!

I've received derisive emails about my (so-far-incorrect) recommendations to sell gold. One email said my column was "one of the silliest pieces of market advice I've ever seen." Another said, "I've been waiting for a pullback to buy more gold, but after reading your column today, I will resume buying this week."

Hot-under-the-collar reactions to a prediction that a multi-year price trend will reverse is the clearest sign that the trend will indeed reverse. If you are selling stocks at a time when others consider it preposterous to sell, it's vital to keep your mouth shut about it. Avoid ridicule from friends that might persuade you to change your mind.