For many Americans, individual retirement accounts (IRAs) and other retirement plans and pensions often represent their most valuable assets. Along with the home, these retirement vehicles are the most likely assets to avoid consumption or loss of value over the course of the owner’s life. Unfortunately, many Americans often neglect to calculate their retirement account’s impact on their overall estate planning efforts – and that can lead to unexpected negative outcomes when they die. Unless you coordinate your IRA with the rest of your estate plan, your heirs may not receive the full benefit of the inheritance you provide.
Retirement accounts always present unique challenges for estate planning, since they are treated differently than most other types of inheritance. Inherited property is, as a general rule, free from income tax liability. That is not true with retirement accounts like IRAs, however, since standard IRAs are not taxed at the point of contribution – which is one of their main selling points, after all. Because of that, however, these accounts end up being taxed when the beneficiaries start withdrawing money. Naturally, that reduces the value of the account that is being inherited, unless your estate plan is designed in a way that enables those taxes to be deferred.
Planning – Both Simple and Complex
There are a number of important things to consider when you’re trying to coordinate your IRA and estate plan. The most important is to ensure that you have named a beneficiary for your account, as well as contingent beneficiaries who will receive the account if the primary beneficiary passes away. When your spouse is listed as the beneficiary of your IRA, that poses little difficulty. However, when someone other than a spouse inherits your IRA, that person must begin taking withdrawals no later than one year after you died.
That’s the fairly simple part of the planning process though. There are far more complex issues that need to be considered, including options for stretching out an account to ensure that benefits remain in the IRA for your heirs. That can be an especially useful option when you are financially secure and don’t actually need the IRA funds during your retirement. You simply take the very minimum amount of required distributions, and leave the bulk of your funds in the account so that they continue to grow in value over time. After your death, your named beneficiary either receives the benefits of that additional wealth or can repeat the stretching process again – this time for a beneficiary that the new account owner designates.
You may even need to consider options that would unite the benefits of a trust with your IRA. That would entail creating a trust and listing the new legal entity as your account beneficiary. This option is useful in cases where you have disabled heirs, young children, or spendthrift beneficiaries who would otherwise waste their inheritance. When the trust is properly created, you can ensure that the IRA distributions can be taken throughout the oldest beneficiary’s anticipated life expectancy.
Tax Planning Concerns
One of the biggest problems created by IRAs occurs when the account owner dies and the IRA begins to face potential tax questions. This can even result in the funds being taxed twice – once in the form of estate tax liability, and a second time when the beneficiaries take distributions. If the decedent’s estate is valuable enough to make it subject to the estate tax, then the potential tax liabilities could substantially reduce the size of an heir’s inheritance. Obviously, that is something that most people would like to avoid.
There are, however, tax reduction strategies that you can utilize in your estate planning to decrease the tax liability your estate and heirs might someday face. One strategy involves spending down the assets by taking distributions while you’re still alive. There are problems with this tactic, though, since large distributions could increase your marginal tax rate. Still, if your estate is large enough, an increase in income tax rates could still save you money when compared to the 40% estate tax you might otherwise incur.
Alternatively, you can use various strategies to delay any tax obligations through the use of deferrals. This can include delaying those taxes until the original account owner is 70 ½ years old, or arranging things so that no tax is due until your spouse passes away too. Of course, these options work best when you don’t actually need to take distributions from your account.
Why it Matters
IRAs are unique types of property that must be addressed within your estate planning strategy if you want to maximize their value for your heirs. If you fail to do so, you could end up in a situation where your heirs must withdraw large amounts of money within a short period of time. Depending on the tax rates in effect at the time of the withdrawal, that could be a costly mistake. Moreover, without a beneficiary designation on your account, heirs will have only a relatively short time to take all available distributions.
The good news is that sound estate planning can work to maximize the benefits your IRA can provide, while minimizing income tax and estate tax concerns. These are not simple issues, though, and no one should try to achieve these goals on his own. Any strategic plan involving an IRA should only be attempted with the assistance of an experienced estate planning attorney.
At the Augulis Law Firm, our estate planning team has the experience and expertise you need to navigate the complex maze of individual retirement account concerns. We can help you determine which type of IRA works best for your needs, how your account beneficiary designations can be leveraged to maximum benefit, and how the value of your account can be best preserved over time. Most importantly, we can help to ensure that your IRA doesn’t create unforeseen complications for your estate planning. To learn more, contact us online or call us at (908) 222-8803 today.
Alan Augulis, Estate Planning Attorney
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