When planning for retirement using IRAs or other savings tools, keep in mind the goals of your estate plan. Your beneficiary designation for your IRA could lead to a significant tax impact after your death, if there is money left in the account. If you have not reviewed your IRA details in years, now is a great time to update beneficiary designations to align with your estate planning.
People saving for retirement place money in IRAs with the intention of withdrawing the money during retirement. The government defers tax assessments on money placed in traditional IRAs until it is withdrawn. You must start taking required withdrawals from an IRA on April 1 of the year after you reach age 70 ½. Many Americans, however, die with money still in the accounts. At this point required withdrawals of money must be made from the accounts until they are empty.
If the IRA accountholder names a living individual beneficiary and the accountholder dies before April 1 of the year he turns 70 ½, the beneficiary can make the required withdrawals over the course of his or her projected life expectancy. If the accountholder dies after that April 1 date, the beneficiary can make withdrawals over the course of either his life expectancy or the accountholder’s, whichever is longer. As a result, the amount of taxes assessed on withdrawals tends to be lower than if the withdrawals were made over a shorter timespan. This is because the amounts withdrawn each year over a long timespan will be lower, so the beneficiary may not fall into a higher tax bracket because of a large withdrawal.
In contrast, if the IRA accountholder names a deceased beneficiary, names his estate as the beneficiary, or names a beneficiary in a will without officially adding the beneficiary to the account information, and he dies before the April 1 date, all money in the account must be withdrawn within 5 years. If he dies after the April 1 date, the remaining money in the account must be withdrawn and taxed over the deceased accountholder’s remaining life expectancy. The accountholder may have a projected 5 years of remaining life expectancy at his or her death, causing an accelerated withdrawal and taxation schedule. If instead he or she had named a younger beneficiary, the beneficiary might have 15-20 years of life expectancy, substantially lowering the required withdrawals and taxes.
The accountholder can name a trust as beneficiary of an IRA, but the trust document must include specific “look-through” language. Naming a trust as beneficiary allows the trust to receive the required withdrawals and pass on the money to the trust’s beneficiary. If the trust does not include the “look-through” language, then the IRA money must be withdrawn and taxed over the accountholder’s life expectancy – the same result as if the accountholder left the IRA money to his or her estate. The accountholder also can name a charity as beneficiary of an IRA. A charity holding 501(c)(3) tax exempt status will not pay tax on money in an IRA if it is the beneficiary.
Please note that the IRS has different taxation rules for Roth IRAs than those described above. Taxpayers have already paid taxes on Roth IRA contributions in the years they were made, but amounts remaining in a Roth IRA on death become part of the estate for purposes of estate taxes. In addition, giving your IRA money to a trust or other non-individual beneficiary can have far-reaching consequences for the rest of your estate plan. If you plan to do so, seek out legal advice.
Planning your estate? Angela Klenk, Esq. and the team at Beach Cities Estate Law couple personalized attention to your estate plan with big law firm experience for a winning combination to give you peace of mind. To schedule a case evaluation, visit Beach Cities Estate Law online or call Angela’s office at (424) 400-2125.