Be careful who inherits your IRA, and be smart about how they are allowed to do it. It could save them a potentially 40% tax hit.
Without proper planning, your IRA could easily become a tax nightmare. However, you can avoid this tax trap by properly planning your beneficiaries, picking the right retirement account type, and making sure to find the proper adviser to help with the process.
Changes in the new millennium
Beginning in 2002, a few significant changes occurred for IRAs and the policies that govern their distributions. Life expectancy tables were updated to reflect longer life spans, more options if the account owner's spouse was more than 10 years younger, and the Separate Account Rule was implemented. Essentially, this rule allows account owners to choose how their beneficiaries would receive the remaining funds in their retirement — either in a lump sum (the previous mandatory policy) or allowing the funds to continue earning tax-deferred benefits.
A Stretch IRA can save your beneficiaries (and potentially, if planned properly, their beneficiaries) thousands of dollars in unforeseen taxes. A Restricted Beneficiary Form can designate the creation of a separate account for each beneficiary in their name. However, your beneficiaries will need to begin their RMDs starting the year after your death, not by age 70½ (the age you would typically start distributing RMDs). They must pay taxes on only the amount withdrawn every year from the retirement accounts, taxed as ordinary income.
Picking your Beneficiaries
Things to keep in mind
- If you have no beneficiaries listed or the designated beneficiaries have passed away without any others listed, the account will end up in probate and be subject to taxation vs. going to a survivor of the original account owner.
- Depending on the account (employer-sponsored plan vs. IRA or Roth IRA), different rules may come into play. Most company plans, such as 401(k)s, normally transfer account values to the spouse automatically, while IRA rules may vary by state. Updating your beneficiaries in the event of a divorce or marriage is therefore important because most laws favor spouses.
- Make sure if you name minor children that you've appointed a proper guardian who can manage the accounts until the minor becomes an adult.
- Change beneficiary designations after major events like weddings, divorces, births, deaths or illnesses.
- Beneficiary designations do not carry over when you transfer or rollover funds to a new custodian or institution.
- Can you save too much in your 401(k)?
This article was provided by Carlos Dias, Jr., a financial adviser, public speaker, and president of Dias Wealth, LLC, and brought to you by the Ronald J. Fichera Law Firm, where our mission is to provide trusted, professional legal services and strategic advice to assist our clients in their personal and business matters. Our firm is committed to delivering efficient and cost-effective legal services focusing on communication, responsiveness, and attention to detail. For more information about our services, contact us today!
This article was written by and presents the views of our contributing adviser. This is not tax advice and should not be construed as such. Please seek professional tax services for more information and advice that will apply to your specific tax situation.