Don't Give Your Nest Egg to Uncle Sam

Avoid simple mistakes that can trigger a big tax bill.
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How would you feel if you lost nearly half of your retirement money? No, not to another bear market -- but to Uncle Sam! It's a horrifying possibility. But it could happen if you don't pay attention to the rules of your retirement accounts, or if you fail to name the correct beneficiaries to your account, or if your heirs don't understand the proper way to roll over or withdraw your retirement funds after your death.

That scary scenario is the premise of Ed Slott's new book,

Your Complete Retirement Planning Road Map

(Ballantine, $25.95). Slott is an expert on the rules of IRAs and 40l(k)s as they relate to withdrawals during your lifetime and for the money left over after your death.

This is not a book about investing in your retirement plans, or asset allocation, or fund choices. Slott says he presumes his readers are making regular contributions, and have diversified their investments. Instead, he's organized this book like a checklist for servicing your new car: you may not know what's under the hood, but you should make sure that all the required service steps are taken.

Whether it's ordinary precautions, such as naming the correct beneficiary for your IRA, or strategic decisions, such as deciding whether to roll your 40l(k) plan into an IRA when you switch jobs (generally a good idea), or dealing with the complexities of retirement plan assets in divorce, Ed Slott has the advice you need to avoid making expensive mistakes.

When I asked about the simple mistakes people make, Slott's answer reminded me of those annual reminders to "sign your tax form." The most important thing is to make sure you've actually signed a beneficiary form for each retirement account. Next, you need to make a copy of the form you signed with your bank or broker, and leave it with your documents so the account is not overlooked at your death.

It's the little things that count, and during our conversation Slott continually reminds me that by the time someone figures out you've made a mistake -- after your death -- it will be too late to do things the correct way!

Step 1. Getting Organized

People will likely work for several different companies in a lifetime, and may also set up individual retirement accounts, and different types of IRAs, including after-tax, pretax and Roth. Slott says the first step is creating an inventory of where everything is -- and writing it down!

This is about more than just account numbers and valuations. Each plan custodian has a different set of rules, within IRS and legal constraints. Understanding the withdrawal rules, borrowing rules from company plans and ongoing costs may encourage you to consolidate where appropriate, making life simpler for future withdrawals and for your heirs.

Step 2. Checklists

The next step is creating a beneficiary checklist. This is important, he notes, not only after your death, but because it could affect the required minimum distributions you must take during your lifetime, and thus the amount left to your heirs. It's important to update this list if your marital status changes or if one of your beneficiaries precedes you in death. The beneficiary document, Slott points out, "trumps all other documents, including a will, in determining where the money goes after you die."

Other issues to consider: Are two people "co-beneficiaries" or is one a primary beneficiary? Have you named a "contingent" beneficiary in case one predeceases or disclaims the inheritance? If one beneficiary dies is that person's share distributed "per stirpes" to his or her children?

Step 3. Legal Issues

It's important to check the rules of your company plan or IRA custodian. Some have rigid rules and will not allow lifetime payments to be made to a young beneficiary. Some won't allow the beneficiary to transfer assets to a different custodian. Some won't acknowledge a trust as a beneficiary.

Slott's book covers the new rules that are just going into effect for direct rollovers from company retirement plans to "Inherited IRAs" -- a specific procedure that must be followed to stretch out the growth and ultimate withdrawals from an IRA that is not inherited by a spouse.

Step 4. Special Situations

Divorce is one of the special situations covered in depth in Slott's book. "Make a mistake," he says, "and the retirement plan assets will end up taxable to one or the other of the spouses." Slott explains that a retirement plan can be split in a divorce and keep its tax-sheltered status, but most attorneys don't know how to correctly word the division.

If it's a 401(k) account, the plan must be served with a qualified domestic relations order. One tip: the non-employee spouse should then roll his or her portion of the account into an individual IRA, giving more flexibility. Left in a former spouse's plan, distributions may be restricted until your ex-spouse retires!

Dealing with retirement account issues is not a linear process. As Slott notes, it can't easily be reduced to steps or order of priority. Each of his checklists leads to another, depending on your answers to each question. With substantial retirement assets, you might need individual help. You can search for one of the "Elite IRA" financial advisers or attorneys that Slott has personally trained and certified by going to his Web site:

But even if you're dealing with a relatively small amount of money, it's worth making the investment in Ed Slott's new book. And that's The Savage Truth.

Terry Savage is an expert on personal finance and also appears as a commentator on national television on issues related to investing and the financial markets. Savage?s personal finance column in the Chicago Sun-Times is nationally syndicated, and she released her fourth book,

The Savage Number: How Much Money Do You Need?

in June 2005. Savage was the first woman trader on the Chicago Board Options Exchange and is a registered investment adviser for stocks and futures. A Phi Beta Kappa graduate of the University of Michigan, Savage currently serves as a director of the Chicago Mercantile Exchange Corp. She also has served on the boards of McDonald?s and Pennzoil.