What You Need To Know About IRAs: Bankruptcy, Inheritances, And More

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IRAs have existed since 1974. Even after nearly 50 years, many misconceptions about IRAs exist among the 47.9 million families who utilize them to save for retirement.

Social Security and Your Expenses
Social Security and Your Expenses

Here are some frequently ignored facts concerning IRAs:

Do you have a limit on how much you can give, and is it tax deductible?

According to experts, account holders frequently forget how much they may contribute to an IRA. The IRS occasionally modifies the amount that can be contributed to an IRA. You may contribute up to $6,000 ($7,000 if you’re 50 or older) or your taxable earnings to your conventional and Roth IRAs in 2021.

According to experts, account holders frequently forget if their contributions are tax deductible. Yes, the deduction may be limited if a workplace retirement plan covers you or your spouse and your income reaches a specific threshold.

“Many account owners are unaware that they may be able to contribute to an IRA even if they have a 401(k),” explains Phillis Sax Pilvinis, founder of PSP & Associates Inc. Retirement Wealth Strategists.

If you have questions about the yearly IRA contribution limit, check the IRS’s website for further information.

What to invest in?

Account holders are not usually aware that an IRA is a tax status and not an investment vehicle, according to Sax Pilvinis. Account holders can invest in nearly anything except life insurance or collectibles such as artwork, antiques, stamps, comic books, most coins, alcoholic drinks, and other tangible personal property, even though it is not an investment vehicle.

When in doubt, consult the IRS website.

Who will inherit my IRA?

Many account holders wrongly believe that their heirs will receive their IRA by specifying their preferences in their will. However, when a person dies, IRAs are not transmitted in this manner. Instead, IRA and 401(k) account holders must name a beneficiary as well as a contingent beneficiary, according to Jeannette Bajalia, president of Petros Financial Group.

“In essence, the beneficiary form is the will for the IRA,” says Joe DiSalvo, certified financial consultant, president of Quest Capital & Risk Management, and co-author of “Income for Life: The Retiree’s Guide to Creating Income From Savings.” The typical individual, as well as many brokers, are unaware of this. Most individuals cannot get beneficiary designation documents, and many are filled out erroneously. Check and update the primary and secondary beneficiary designations on your retirement accounts and insurance plans.

A tax time bomb in the making

Once upon a time, those who inherited an IRA could distribute assets from it throughout their lives. That’s over, and the SECURE Act effectively ended what advisors called a “stretch IRA.”

All assets in an IRA must be distributed within ten years after inheritance. And because of that, says Bajalia, IRAs have now become taxed time bombs to their beneficiaries. 

Because distributions are taxed as regular income, the beneficiary’s income may be pushed into a higher tax category. Be careful of your beneficiary’s tax position, advises Bajalia. Spending all your IRAs during your lifetime can make sense rather than passing the tax burden on to offspring in higher tax brackets.

Speaking about tax bombs, owners of IRAs often overlook that the assets in their accounts lack a cost basis. The entire amount is taxed as regular income, explained Bajalia, and there are no loses or wins.

Given this, one should anticipate that the gross value of one’s IRA account will not match the after-tax value.

There is no 60-day rollover.

Many non-spouse IRA recipients believe they may conduct 60-day rollovers of inherited IRAs. In reality, beneficiaries other than spouses can only perform direct transfers, says Ian Berger, an IRA analyst at Ed Slott & Co.

He points out that if an inherited IRA is paid to a non-spouse, the whole IRA is taxed to the recipient. As a result, advisers must ensure that a client’s IRA custody arrangement permits a non-spouse beneficiary to shift assets via direct transfer. Otherwise, a custodian might hold the inherited IRA funds captive.

Complete creditor security.

Another common myth, according to Berger, is that IRAs provide total creditor protection against lawsuit judgments against the IRA owner. “Because IRAs are not ERISA (Employee Retirement Income Security Act) plans,” he explained, they do not enjoy the ironclad security that ERISA plans give.

He points out that IRAs are protected from bankruptcy creditors up to a specified financial limit ($1,362,800 in 2021), which does not include rollovers from workplace plans.

Berger says this corresponds to total bankruptcy protection for most IRA owners. However, protection from non-bankruptcy judgments is state law dependent, and some states give comprehensive protection, while others provide just partial protection.”

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