One huge benefit of IRAs – the favorable tax treatment received by beneficiaries – is messed up on a regular basis.

An heir gets to stretch withdrawals from an inherited IRA across his own life expectancy.  This means that the assets within the IRA could increase in value for decades, completely tax-deferred.

So how does it get messed up?  By no planning, poor tax planning, or just plain ignorance.

Some heirs will promptly cash out an IRA.  That is the worst action they could take, because the tax becomes immediately due on the entire amount.  Once the IRA is cashed out, there is no grace period to get the money back into the IRA.

Some IRA owners will make a trust the beneficiary, thinking they are avoiding probate or protecting the assets.  The problem is that the trust isn’t a person and has no life expectancy – thus, there isn’t a stretch on withdrawals.  Most attorneys advise keeping an IRA out of a trust.

Sometimes an heir simply pays the tax twice.  This can happen if the estate was large enough to pay estate taxes (the 2013 exemption will be $1 million unless Congress acts).  The heir is entitled to deduct “income with respect to the decedent” on his payment of IRA taxes.  The solution is simple – an heir should always ask if the Estate paid any taxes.

Some heirs mistitle their inherited IRAs, and the IRS disqualifies the account.  One  suggested way to title an inherited IRA is “John Jones, deceased (dated of death) IRA F/B/O (for the benefit of) Bill Jones, Beneficiary.”

Finally, an heir or beneficiary can actually disclaim the IRA and pass it on to his children to give them the tax-deferred growth.  This option is available only if the IRA owner filled out the beneficiary designation properly, and the disclaimer is made within 9 months of the owner’s death.

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