In a traditional IRA, the funds contributed grow tax deferred and are taxed at ordinary income tax rates upon withdrawal after age 59 ˝. In a Roth IRA, after tax money is contributed and can be withdrawn tax free after age 59 ˝, provided certain conditions are met. There are important differences between a traditional IRA and a Roth IRA when it comes to estate planning.
With a traditional IRA, you must begin withdrawing required minimum distributions or RMD's, after reaching age 70 ˝. With a Roth IRA, you are not required to withdraw any funds regardless of age. For those seeking to accumulate wealth in an IRA and pass it on to their heirs, a Roth IRA offers significant advantages.
Funds in an IRA with a named beneficiary do not pass through probate upon the owner’s death. If you name beneficiaries on your IRA, the IRA will pass directly to the named beneficiaries upon your death.It is generally not a good idea to name your estate as the beneficiary of your IRA. If you name your estate as the beneficiary, it will subject the funds in your IRA to probate and creditors claims. When deciding whether to name your spouse as beneficiary or a nonspousal beneficiary, it’s important to consider the size of the IRA, the time period in which the beneficiary would be required to withdraw the funds, and the income tax ramifications. Consult a financial planner or estate planning attorney for assistance naming beneficiaries in a way that will achieve your estate planning and tax objectives.
How to Name IRA Beneficiaries
In addition to naming primary beneficiaries on your IRA’s and other retirement accounts, it’s very important to name contingent beneficiaries. A contingent beneficiary will receive the proceeds of the IRA if for any reason your primary beneficiary cannot inherit the IRA or chooses to disclaim it. If you fail to name a contingent beneficiary on all your retirement accounts, you risk having your retirement accounts end up in your estate and subject to probate.
Whether you are making your estate plan or updating it, it’s a good idea to make a list of all IRA’s and other retirement accounts. Use our free estate planning worksheet to organize this information. Then review your account information and paperwork to ensure you have primary and contingent beneficiary designations on each account that are consistent with your estate plan. If you need assistance adding beneficiary designations to your IRA, call the financial institution that holds the IRA or visit their web site for instructions.
If You Inherit an IRA
If you recently inherited an IRA, see Inherited IRA's for informaton you need to make a decision about how to handle the inherited funds.
What is a Stretch IRA?
A stretch IRA is not a special type of individual retirement account or IRA. Rather, a stretch IRA refers to an estate planning strategy designed to keep the original IRA owner’s funds invested in the IRA and growing tax deferred for as long as the law allows, thus reducing income taxes and the amount of required distributions from the IRA. The goal of the stretch IRA concept is to stretch out distributions from the original owner’s IRA funds over one or two generations. Since a much younger beneficiary may be named on an IRA, such as the IRA owner’s child, the required minimum distributions from the IRA will be much less and stretch over a longer period of time.You may want to use a stretch IRA in your estate plan if:1. You and your spouse will not need all the income from the IRA during your lifetimes.2. You want to minimize income taxes on your IRA withdrawals to the greatest extent possible.
3. You want to use the funds in your IRA to benefit your family.
Naming Your Spouse As Beneficiary
If you name your spouse as beneficiary, upon your death, your spouse can roll over the funds from the IRA to his or her own IRA and then withdraw the funds in amounts and timing based on his or her own age. It can be beneficial for your spouse to roll the funds over into his or her own IRA if your spouse has not yet reached age 70˝, but you had, because it allows your spouse to stretch out the tax deferral of the IRA by delaying required minimum distributions until your spouse reaches age 70˝.
If you are concerned about estate taxes, you can leave your entire IRA to your spouse and they will generally not be subject to estate tax because of the marital deduction. Upon your death, if your spouse determines they do not need the funds in the IRA, your spouse may choose to disclaim all or a part of the inheritance and allow it to pass to the other beneficiaries of your IRA, such as your children or other family members. Such disclaimer must be done within nine months of the IRA owner’s death.
The distribution rules for inheritances from an IRA are complex and vary depending on a variety of factors such as: 1. age of the IRA owner at time of death; 2. age of the beneficiary; and 3. relationship of the beneficiary to the IRA owner. Therefore, it is important to consult a tax advisor, financial planner or estate planning attorney about the distribution rules and taxes that will be applicable to any IRA funds left to your beneficiaries.
Living Trusts and IRAs
If you are considering naming your living trust as the beneficiary of your IRA, talk to an estate planning lawyer first. Because the funds in the IRA do not pass through probate if you name a beneficiary, you do not need to name your living trust as beneficiary of the IRA to avoid probate. See non-probate transfers.Also, if you name a living trust as beneficiary, all funds in the IRA must be withdrawn within five years of your death. If you name a person as the beneficiary instead, a longer time period for withdrawal may be available to such person, allowing the IRA to grow tax deferred longer. In general, if you name a person as beneficiary of the IRA, such person can leave the funds in the IRA for a longer period of time, deferring taxes, than if the IRA is left to a living trust in which the same person is beneficiary of the trust.If you have an AB living trust with your spouse, there are some advantages and disadvantages to naming your AB living trust as beneficiary of your IRA, so consult your attorney for more information.
401k's and Your Estate Plan
For information on how to ensure your 401K account is left to your desired beneficiaries and incorporated into your estate plan, go to 401K's and Your Estate Plan.
Charitable Donations From An IRA
If you want to donate assets to charity at your death, a traditional IRA can be an effective part of your estate plan. If you name a charitable organization as beneficiary of your traditional IRA, the charity pays no tax on withdrawals from the IRA and you reduce estate taxes that may be owed on your estate. See charitable giving.
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