Aside from Social Security, individual retirement accounts (IRAs) are at the core of many long-term financial plans. If you are in an especially good position during your golden years, you may never have to use the money in your IRA. In these cases, your account may be part of your inheritance plan.
Traditional Individual Retirement Accounts
The traditional IRA is one of the two most commonly used types of retirement accounts. You deposit money into a traditional account before you pay taxes on the income. In the near term, you get a tax break, because you are claiming less income each year.
On the other side of the coin, you do have to pay taxes on distributions that you take from the account. You can start taking money out of the account without any penalties when you are 59.5 years of age. This being stated, there are a handful of exceptions to this rule.
Younger account holders are allowed to take up to $10,000 out of the account for a first home purchase. You can use money in the account to pay for school tuition, and there is no penalty if you use the funds to pay unpaid medical bills.
From an inheritance planning perspective, this type of account is less than ideal. You have to take required minimum distributions each year when you reach the age of 72. The age used to be 70.5, but it was raised when the SECURE Act was enacted in 2019.
Another change that was implemented when this piece of legislation was passed is positive if you would like to use the account for estate planning purposes. You are now allowed to contribute money into the account for an open-ended period of time.
Before the SECURE Act was passed, when you reached the mandatory minimum distribution age, you could no longer contribute into the account.
The other widely utilized individual retirement account is the Roth variety. With this type of account, the tax situation is reversed. You put money into the account after you have paid taxes on your income, and as a result, you pay no taxes when and if you take distributions.
We are using the word “if” because you are never required to take mandatory minimum distributions from a Roth individual retirement account. The minimum age for penalty-free distributions is 59.5 for these accounts as well.
Individual Retirement Account Beneficiaries
When you establish an individual retirement account, you name a beneficiary. If the beneficiary is your spouse, they could choose to become the owner of the account. The survivor would also have the option of rolling it over into another account.
A non-spouse beneficiary would not be able to become the owner. They would be required to take mandatory minimum distributions, and the payouts would be taxed. Due to a provision in the SECURE Act, the beneficiary would be required to clear out the account within 10 years.
This is a very negative development on the estate planning front. It used to be possible to stretch out the account indefinitely to maximize the tax deferral benefit.
The change is even more damaging for Roth individual retirement account beneficiaries. They also have to take required minimum distributions, but they are not taxed. The stretch Roth IRA was a commonly used estate planning approach for wealthy people with very well-funded accounts.
Though the stretch IRA is not what it used to be, your individual retirement account can potentially be a very useful part of your inheritance plan. If you are currently unprepared, or if your existing estate plan does not reflect your current situation, action is required.
There are a lot of different ways to plan an estate, and the right choices will depend on the circumstances. We can gain an understanding of your estate planning goals, explain your options to you, and help you put the ideal estate plan in place if you decide to go forward.