Dealing With Life-Changing Events

This week, Gail reminds you to update your retirement account in the event of life, death, marriage, or divorce.

Dear Gail,

My uncle was a bachelor — no kids or wife. I'm his only nephew, so when he died a few months back he left me his retirement plan — something called a "Simple" IRA.

I'm not sure what to do with it. Can I roll it into my own IRA? Should I just cash it out? Frankly, it's more money — about $130,000 — than I've ever had in a lump sum before and I don't want to make a stupid mistake. I'm 33, my wife and I both work and are saving as much as we can through our company retirement plans. I don't really need this money right now. What are my options?



Dear Jarrod —

You're smart to think before you touch this money. There are important things to consider when you inherit someone's retirement account; if you make the wrong move, you generally have to live with the consequences. First, SIMPLE is an acronym that stands for "Savings Incentive Match Plan for Employees." It's a retirement plan that only a small business — with 100 or fewer employees- can have. As the name implies, a SIMPLE plan involves minimal red tape, recordkeeping, and cost. One of the ways it accomplishes this is by using IRA accounts for employees instead of 401(k)-type accounts.

Retirement account money — whether it's in an IRA, a 403(b), or any other type of plan — is considered taxable income when it is withdrawn from the account. This is true no matter who makes the withdrawal. If your uncle were alive, he would owe tax on the amount distributed. But since you would be receiving this income in his place, you will be taxed on the amount you withdraw.

The fact that your uncle's IRA was created under a SIMPLE plan should not affect the rules concerning what you can do with this money.

First, you cannot "roll over" this IRA account into one in your own name because this privilege is reserved for surviving spouses. Instead, your uncle's name will remain on the account, with you listed as the "beneficiary" and your Social Security number associated with the distributions.

As a non-spouse beneficiary, your choices boil down to: 1. Cash out the money, or 2. Stretch out the money.

If you cash out the account, you will have to add that amount to your taxable income for 2004. An extra $130,000 could push you and your wife into a siginificantly higher tax bracket than you're in now. Say you end up in the 33% bracket. Cashing out means you walk away with only two-thirds of the value of your uncle's SIMPLE IRA — about $87,000.

Now let's look at your second option. "Stretching" an IRA involves taking just a minimum amount of money each year based on your own (the beneficiary's) life expectancy. In essence, you are "stretching" out the life of the IRA for another generation — yours.

The amount you must withdraw is spelled out by the IRS and is based on your age. And you must start your withdrawals no later than Dec. 31 in the year after the IRA owner died. (In your case, the deadline is 12/31/05).

The IRS isn't very forgiving if you don't take out at least the minimum amount required. In fact, if you take out less than you're supposed to, there's a 50 percent (!) penalty. You might want to consider working with an experienced financial advisor to make sure you get started properly.

While you must take out a required minimum amount each year, you can always withdraw more than than the minimum. Just keep in mind that the larger your withdrawal, the more income tax you will owe.

The key advantage to a "stretch" strategy is that the money that remains inside the IRA can continue to grow on a tax-sheltered basis. This is critical. Not having to pay tax on the earnings on this account every year means it has the potential to grow to a much larger sum of money than it would if it were in a taxable account.

To illustrate this, I'm going to make some assumptions. First, let's say that your uncle's account was worth $130,000 at the start of this year and that it has been invested in a diversified portfolio earning an average annual return of 8 percent. I'm also going to assume that you will not take any money out until next year. This means that at the end of this year, your uncle's SIMPLE IRA will have grown to $140,400 ($130,000 x 8 percent).

Based on your life expectancy (49.4 years) next year your "required minimum distribution" would be $2,842. Based on the scenario outlined above, each year, your withdrawal would increase. Now, let's say you want to take full advantage of stretching out this IRA so you just withdraw the minimum amount required each year for the rest of your life. Assuming this account manages to earn 8 percent per year, instead of receiving $130,000 now, you will receive (sitting down?) a total of more than $1.8 million dollars over the course of the next 49 years!

That's the potential reward for allowing compounding to work its magic in a tax-deferred account.

Cup-half-empty folks are quick to point out that that's the amount you receive before taxes are paid. Big deal. Would you rather pay taxes on $130,000 or $1.8 million? No matter how you slice it, the bigger the amount, the more money you end up with — even after you account for taxes.

Your uncle was clearly very fond of you. I'm sorry for his passing. Honor his memory by being a good steward of what he has left you.

Best wishes,



Hi, Gail —

I'm saddened (but relieved) to say my husband and I just finalized our divorce, ending a 28-year marriage. We've got two kids who are almost on their own — one's a senior in high school and the other's a junior in college.

Based on the recommendation of a friend, I went to see a financial advisor to figure out what to do with my half of the property. I just don't want to use the same one my ex-husband and I have used over the years. This advisor specializes in helping divorced women and said I need to change the beneficiary on all of my 401(k) and IRA accounts — taking my ex-husband off and replacing him with my children. But I thought my will took care of that. It seems like a lot of paperwork. Is she right?




Dear Jeanne —

Your advisor is absolutely correct! It's a common misunderstanding that your retirement accounts will be distributed based on whatever instructions are in your will or trust. THIS IS NOT THE CASE.

All retirement accounts — IRA, 401(k), 403(b), 457, SDEP, SIMPLE, etc.— are inherited by the person(s) named on the adoption agreement when you opened the account or began to participate in the plan. This is a binding contract that directs the sponsor of your plan to distribute the balance to the individual(s) named when you die.

Your will or trust has no legal power over this contract. If you don't remove your ex-husband as your beneficiary, when you die he — not your children— will inherit your retirement account even if your will/trust says everything you own goes to your kids!

While you're at it, be sure you also name a contingent beneficiary for each account. This is the person you want to inherit the account if (God forbid) neither child is alive to receive it.

If you die with no beneficiary — because the person you named died before you did — your IRA will likely end up going to your estate and will have to be probated.

What's worse, no matter who eventually receives the account, they will not be able to "stretch" out the required withdrawals (see above), but will have to cash it out.

Your beneficiary designations are not locked in for life. You and your advisor should review your beneficiary designations periodically, especially if your situation changes. For instance, at some point you might want to add a grandchild as a contingent beneficiary.

I ususally tell people to take it slow and not rush to make any major financial decisions when they go through a life change as significant as divorce, or the death of a spouse. But updating your beneficiary designations is one thing you should take care of as soon as possible. Your new financial advisor can help with the paperwork.

Best wishes,



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The views expressed in this article are those of Ms. Buckner or the individual commentator, and do not necessarily reflect the views of Putnam Investments Inc. or any of its affiliates. You should consult your own financial adviser for advice regarding your particular financial circumstances. This article is for information only and is not an offer of the sale of any mutual fund or other investment.