IRAs (individual retirement account) were introduced in 1981. Initially, IRAs were set up to enable anyone with at least $2,000 of earned income to contribute up to $2,000 each year and take a tax deduction for the full amount of the contribution. IRAs are much more complex these days. There are also the Roth IRAs and the Education IRAs but first you must understand the rules of the Traditional IRA.

The Traditional IRA is a good way to save for retirement. Tax deductions and tax-deferred growth are the main reasons people choose an IRA as part of their financial planning. Choosing the right beneficiary is vital for your IRA. Beneficiary rules are more complex than you think. The wrong choice of a beneficiary can be costly. Read the following before making an IRA part of your estate plan.

IRA Beneficiaries

If you name an estate as the beneficiary, the estate has no life expectancy and after the age of 70 and one half, will require larger minimum annual distributions. If a person is named the beneficiary, a joint life expectancy can be used to compute required minimum annual distributions.

If you name a charity as the beneficiary,charities pay no income tax and can receive IRA distributions tax free. Do not name a charity as one of several beneficiaries to your IRA. Have a separate IRA to hold funds that you want to leave to charity and name the charity as the only beneficiary. A charity has a zero life expectancy and again will increase minimum annual distributions and reduce the amount of funds that stay in the IRA. Remember, the owner can use a joint life expectancy computed with that of the beneficiary who has the shortest life expectancy of all the beneficiaries to the IRA.

If you name a minor child as the beneficiary a court-appointed legal guardian must be named to administer the IRA funds on the child's behalf. You can leave the IRA funds to a trust that you set up on the child's behalf or a custodian who will act on behalf of the minor child under the UTMA if recognized in your state (Uniforms Transfers to Minors Act). Under the UTMA, the child will receive direct control over the IRA when they reach the age of 18 in most states.

It is important to name a person to take the place of a primary beneficiary who may die before you or with you. If you name your spouse as your beneficiary and you both die in an accident, there is no beneficiary for the IRA. The IRA will be liquidated, taxed and paid to your estate. Name a person to take the place of your spouse if such an accident should occur and the IRA will remain earning tax-deferred investment returns for years to come.

IRAs and Taxes

Payouts from regular IRAs are subject to income tax. If an IRA is the largest asset in your estate, distributions from it may be required to get funds to pay the estate tax due on it, putting the estate in a double-tax situation. One of the most common mistakes people make is neglecting to figure estate taxes on their IRA.

If you leave funds in an employer plan, the plan may be terminated prematurely. If the company is acquired, merges or goes out of business and you have not rolled the funds in an IRA, the result will be an early, taxable distribution. If you roll over the funds into a IRA of your own, you gain more control over investing options and distribution planning.

Mandatory withdrawals must be taken before an IRA is switched to a Roth. This rule will change in '05, when required payouts won't count. Some people are deterred from using the Roth IRAs. The tax benefit they provide (tax-free distributions of earnings after the age of 59 and one half), comes with an up-front tax cost. Roth IRAs have no minimum annual distribution requirements and create more planning options than are available from regular IRAs. Roth IRAs are more complex. Watch for the Roth IRA article coming soon or call your accountant for details about Roth IRAs.

Beware of misleading sales pitches for specific IRA investments via the telephone, the mail or sometimes even the Internet. The fraudulent promoter tries to convince the consumer that the investment is safe, can be used for IRAs and has been approved by the IRS. The IRS does not review or approve investments or offer advice on how to invest in IRAs.

Most financial experts agree that the Traditional IRA is a good way to save for retirement. As a general rule, you can gain the advantage of tax deferral at a low cost by investing your IRA in a mutual fund that maintains low operating expenses. You can invest your IRA in a range of investment alternatives and tailor your retirement savings program to your specific needs. An IRA may earn tax-deferred investments returns for three generations. Careful planning and managing your IRA can produce generations of tax-favored investment returns for your heirs.