Thousands of taxpayers inherit money each year. But few are aware of a tax break that's designed to prevent Uncle Sam from pocketing as much as 90% of such inherited assets as individual retirement accounts, 401(k)s, and annuities, says Ed Slott, editor of Ed Slott's IRA Advisor newsletter (800 221-1809; irahelp.com). If your benefactor's estate paid federal estate taxes on your inheritance, you're entitled to take this deduction, which is called Income in Respect of a Decedent (IRD). For example, if you inherited a $1.2 million IRA that paid $500,000 in federal estate tax, you can deduct $500,000 -- but you'll have to spread it over the years in which you withdraw money from the IRA.
If you have failed to claim this tax break, you can amend your past three federal and state returns. You can take the IRD deduction even if you're forced to pay the alternate minimum tax, an extra tax that's calculated by wiping out many deductions. Better still, although you claim the IRD as a miscellaneous itemized deduction, you won't lose any of it to the rule that says you can deduct amounts only in excess of 2% of your adjusted gross income. Want to serve a unique whiskey at your next party? Just buy a barrel of Jack Daniel's Single Barrel Tennessee Whiskey for about $9,000. You can take a private tour of the Lynchburg distillery, sample four barrels, and pick your favorite. If you can't go there, Jimmy Bedford, the master distiller, will choose for you. There are differences: One barrel may have a stronger toasted oak flavor, another more of a vanilla presence. The elixir then goes into 240 bottles with a neck medallion stating the whiskey was distilled especially for your occasion, company, or private collection. Trading costs can take a big bite out of a mutual fund. Finding out just how big is tough. You need to dig through regulatory filings, and even then it's difficult to know exactly how much.
A new study commissioned by Zero Alpha Group, a consortium of financial advisers, provides a good estimate. Researchers examined annual reports for 3,330 stock funds filed in 2001. Because fund companies often lump many funds in one report, it's nearly impossible to get brokerage commission data on a fund-by-fund basis. The researchers, instead, looked at a group's totals and estimated each fund's commissions based on its size. They also combed the "statements of additional information," which include data not in the prospectus. Finally, they tapped into Morningstar's database to measure turnover -- how often a fund trades.
The average annual trading cost, they found, was 0.27%, or $27 on a $10,000 investment. We also asked the researchers to find the five funds (table) with the highest brokerage costs as a percentage of assets. Fidelity Investments, with three funds on the list, didn't dispute the figures but said there are conflicting theories on how to calculate these costs. AIM Investments declined to comment. Putnam says costs have declined since 2001.
However you slice it, the reporting requirements for funds are inadequate. Says Edward S. O'Neal, an assistant professor of finance at Wake Forest University and one of the study's authors: "The SEC should require funds to report commissions in the prospectus, so there are no hidden costs."