If you have accumulated a fairly large IRA during your career like many boomers, there are a number of important planning steps you should take for its distribution in case your IRA outlives you. You do not generally fund your trust with your IRA or list the trust as a beneficiary, so it is often overlooked in estate planning appointments. However, the IRA can generate one of the largest tax bills of any asset.
The first important fact to recognize is that an IRA does not receive a “step up” in basis like stock or real property would. It is called “income in respect of the decedent” and it is taxable to beneficiaries the same as it would be taxable to you. Additionally, beneficiaries frequently only have a very limited time to cash out the IRA, which could result in them paying exorbitant tax rates. To make matters worse, an IRA is subject to the death tax just like the rest of your assets. So combining an income tax and a death tax could create an exorbitant tax bill. However, there a few easy steps you can take to prevent the IRS from being the major beneficiary of your IRA. By creating a stretch IRA, the beneficiary can take smaller distributions each year, thereby preventing their income from ballooning in only one year.
Designate a Beneficiary. Designate regularly and designate often. Financial institutions are notorious for losing beneficiary paperwork and beneficiary listings. You may be shocked to find that your beneficiary listing has disappeared. Just a quick check will let you know who is listed to receive your retirement account. If you do not name a beneficiary, then your estate will become the beneficiary. Typically the IRA must be cashed out within five years if the estate is the beneficiary.
Check your plan. Although the IRS will allow your beneficiaries to stretch your IRA payments over time, some financial institutions are less generous. Verifying with your bank that they will allow for an IRA to continue to be held essentially indefinitely is vital to the success of your plan. If a stretch IRA violates their policy, then the beneficiary will most likely have to cash out.
Educate your Beneficiaries. There is only one basic way to title a stretch IRA. Many spouses simply roll the IRA into their own account. Many non-spouse beneficiaries attempt a 60 day rollover, which is not allowed. However, a stretch IRA basically remains in the decedent’s name. For example, if Jane Doe’s father John dies, his account should be re-titled to say “John Doe IRA (dec’d) FBO Jane Doe” in order to allow Jane to continue to receive required minimum distributions (RMDs) based on her life expectancy instead of John’s accelerated withdrawal schedule. Failure to properly title the account could be deemed a distribution, making the entire amount taxable to the beneficiary. Educating them in advance could prevent this unfortunate mistake.
You should speak with a knowledgeable attorney or financial advisor about the impact a stretch IRA could have on your and your family’s tax situations. The law surrounding IRAs is dense and complex and one false move could trip a tax landmine that you never saw coming. However, using the law to your benefit could create a tax-advantaged account that is able to continue a pattern of growth for a few generations if done properly!
Estate Planning: The Price of Organization, Rewards, Gifts, and Wondrous Tax Things…
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