You’ve Inherited an IRA. Now What?

Inheriting an IRA is quite a bit different than inheriting any other asset. Unlike cash or investments in a traditional investment account, if you inherit an IRA you’ll need to start withdrawing from the account in order to avoid hefty penalties. In this post we’ll cover what your options are when you inherit an IRA, and how you can best manage it for you & your family.

How IRAs are Passed After Death

Whereas many of your assets will be distributed to heirs according to your will, IRAs are instead distributed by contract. Your custodian (the brokerage firm that holds your account, like Vanguard or TD Ameritrade) lets you designate as many beneficiaries and contingent beneficiaries as you like. Once you die, your account bypasses your will, the probate process, and is distributed according to this beneficiary designation.

When account holders don’t designate any beneficiaries things get a little murkier. When the account holder dies, their account is distributed according to their custodian’s default policy. At most custodians this default policy diverts the IRA back to their estate (and goes through probate) but at some it’s diverted to their spouse first. Unfortunately, if the account holder didn’t designate a beneficiary while they were alive, you’re at the mercy of your custodian’s policy.

If the account is indeed diverted back to their estate, it’ll be distributed according to your state’s interpretation of their will. And if they didn’t have one (meaning they died intestate), the state will make its own decision on who should inherit the asset.

The moral of the story? Take advantage of the opportunity to bypass probate, and designate your beneficiaries formally while you’re still alive.

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How to Hire an Accountant

Managing your financial affairs is a big job. You have to keep track of your income, manage your assets for long term growth, pay taxes, and arrange for your estate to be distributed after you die.

You can do some of these things on your own. But others, like writing a will, are jobs you’ll probably want to hire a professional for.

Since we’re in the middle of tax season, I thought it might be helpful to cover exactly what to look for when hiring an accountant. Paying taxes is a fact of life. But if you can find creative ways to reduce the amount of tax you pay, there will be more left over for you and your family. It’s for this reason that an accountant is often one of the professionals families hire for money advice.

You can certainly prepare your own taxes if you prefer. Programs like TurboTax and TaxAct provide quick and affordable ways to compile your financial records and file your taxes.

There is no program that can help you with tax planning, though. TurboTax and TaxAct are great for tax compliance, where you’re reporting on transactions that’ve already happened. But if you’d like to know how you might reduce your tax burden in the future, you’ll need some help making decisions on transactions that haven’t happened yet. This is tax planning, and something that many accountants are very good at.

I covered in a recent post how you can tell whether you need to hire a CPA. Today’s post will cover how to go about hiring one if you do.

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Top Strategies for Managing Incentive Stock Options

Incentive stock options, or ISOs, are a pretty common way for companies to compensate management and key employees. Otherwise known as “statutory” or “qualified” options, ISOs are a way to give management a stake in the company’s performance without doling out a bunch of cash.

While they can have wonderful tax benefits, far too many people who own ISOs fail to exercise them wisely. Some estimates even claim that up to 10% of in the money ISOs expire worthless every single year. If you own incentive stock options but aren’t sure how to manage them, read on. This post will cover a few of the top management strategies at your disposal.

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Turbotax vs. Accountant: When Should You Hire a CPA?

Let me start by saying that I’m a big fan of most tax preparation software. Taxes are a cost in and of themselves. Any way to automate the prep and filing process in a compliant and inexpensive way is A-OK in my book.

But even though they’re easy to use, Turbotax and others are still software programs that have limitations just like any other robot. When your financial picture becomes sufficiently complicated, spending the extra cash to hire a professional can actually save you money in the long run. Here’s my take on when you should ditch the software for an experienced professional.

What You Should Know About Tax Prep Software

When people talk about tax in general, there are really two sides to the conversation: tax planning and tax compliance.

Tax planning is essentially planning transactions before they happen, and making thoughtful decisions that will minimize the total amount of tax you owe. Tax compliance, on the other hand, has to do with preparing your return, filling out forms, and reporting on transactions that have already occurred.

While tax prep software is great and all, it’s really only useful for tax compliance. The more complicated your financial profile becomes, the more decisions you’ll have to make, and the more important tax planning will become.

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Mutual Fund Capital Gains Distributions: What They Are & How to Avoid the Tax Hit

If you’ve ever invested in a mutual fund, you may know that they’re required to distribute at least 95% of their capital gains to investors each year. You may also know from experience that these gains are not always welcome since they come with a tax liability attached.

More often than not these capital gains are not large enough to cause investors to stir. But every year there are a few funds that pass massive unwanted gains on to investors, leaving them with a big, stinky tax bill.

This post may be slightly tardy given that some mutual fund families have already distributed their year end capital gains. Nevertheless, it’s an important topic that you should be aware of and keep an eye out for.

If your objective is to minimize your tax bill (hint: it probably should be) you’ll want to know about upcoming distributions at the end of each year, and avoid them when it makes sense. This post will cover exactly what capital gains distributions are, why mutual funds distribute them, and when and how you might want to avoid them.

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401(k)’s, IRAs & Tax Deferred vs. Tax Exempt Investing

Should I contribute to a traditional or a Roth IRA?

This is a big question I get asked fairly frequently. And really, the conversation expands beyond individual retirement accounts. The decision whether to invest on a tax deferred or tax exempt basis is one you’ll likely make many times over your investing career. Some people prefer a exempt account to “get taxes out of the way”, while others prefer to defer taxes as long as possible in order to “let their money work for them”.

In this post we’ll explore the topic and discuss which situations may be best for either strategy. But first, let’s review exactly what tax deferred and tax exempt investing actually are.

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6 Ways to Minimize Required Minimum Distributions

There’s a plethora of tax advantaged retirement accounts out there today. Enough that the acronyms and numbers can get really confusing…

IRA
401k
403b
457
Profit sharing
SEP IRA
SIMPLE IRA

Just to name a few – trust me, there are more. The reason? The government wants us to save for our own retirement. And by offering an array of tax advantaged accounts, they’re incentivizing us to put money away.

But while the tax advantages are great, the government won’t let us shelter our money from taxes forever. When you turn 70 1/2, they’ll force you start taking withdrawals called required minimum distributions, or RMDs. If you don’t you’ll be subject to a hefty 50% penalty.

This poses quite a problem for many retirees, since each withdrawal raises their tax liability for the year. So for those of you who want to keep Uncle Sam’s grimy mitts off of your hard earned retirement funds, here are six ways to minimize your RMDs:

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401k RMD Rules: A Comprehensive Guide

You’re probably familiar with the term “required minimum distributions” (or RMDs for short). They’re the systematic withdrawals that the IRS makes you take out of an IRA after you turn 70 1/2. But what about for 401k and other qualified retirement plans? What are the 401k RMD rules?

While they largely resemble IRA RMD rules, 401k plans have a few subtle but important differences. And since many people these days are staying at their jobs beyond 70 1/2, it’s a situation that more and more people find themselves in.

To help you navigate the waters, here’s a comprehensive guide to 401k RMD rules, which also applies to 403b, 457, and other qualified plans.

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IRA Contributions After 70.5…Can You? Should You?

Recently I had a client in his mid-60s ask me how much longer he’d be allowed to contribute to his IRA. My client was approaching retirement, but wasn’t planning on drawing from the account until he absolutely needed to.

Since he had other financial resources to draw income from his plan was to let the account grow for as long as possible, thereby delaying tax on the gains. This meant contributing the maximum amount to his account each year, and only withdrawing funds when forced to by required minimum distributions.

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5 Times a Roth 401k Conversion is a Good Idea

Roth IRAs have become one of the most popular ways to build retirement savings over the years. In fact, they’re so popular that thousands of people clamor every tax season to convert their traditional IRAs to Roth IRAs.

This conversion is one of the most popular financial planning moves, since it can reduce your tax burden and eliminates required minimum distributions (RMDs).

More recently, a new form of Roth account has emerged: Roth 401k plans. Roth 401k plans are essentially the same alternative to traditional 401k plans that Roth IRAs are to traditional IRAs. Contributions are made after tax, and gains and withdrawals are tax free.

And with Roth 401k plans on the scene, many sponsors are starting to allow their participants to convert their traditional, pretax 401k balances into Roth, after tax balances. This transition is known as a Roth 401k conversion.

Roth 401k conversions are not unlike Roth IRA conversions. The transition will create taxable income, but your assets will never leave your employer’s 401k plan.

Here’s how one might work:

Johnny has a $100,000 saved up in his employer’s 401k plan. He didn’t pay any income tax on his contributions, and they will continue to grow tax free until he starts taking withdrawals.
When he starts taking withdrawals after age 59 1/2, he’ll owe income tax on every dollar he takes out of his account.
If Johnny were to convert his 401k contribution to Roth contributions, he would owe income tax on the entire $100,000 this year. His account would continue to grow tax free as it would have otherwise.
But, when he begins taking withdrawals down the road, they won’t be taxable income to Johnny. Essentially, he would be paying his tax burden now instead of later.

Conversions can be appealing. You pay taxes on the account now, rather than in the future when you might be in a higher bracket. But the decision is not always so cut and dry. And since this is a question I get in my practice from time to time, I thought it’d help to share 5 circumstances where a Roth 401k conversion is a good idea.

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