For many of our clients, assets held in retirement accounts comprise a significant portion of their estate. With the decrease in the number of companies offering defined benefit pension plans, planning and saving for your own retirement has taken on heightened importance in the past several years.
According to the Investment Company Institute, Americans have approximately $24 trillion invested in retirement accounts, including IRAs and other retirement vehicles. This article will focus on IRAs. If you have other types of retirement plans, review the plan documents prior to taking action.
Generally, married couples name each other as the beneficiary of their IRAs. This is because a surviving spouse is entitled to rollover the deceased spouse’s IRA into his own IRA. These, and other tax benefits, do not apply to other non-married beneficiaries. However, if the surviving spouse is receiving long-term care or is on Medicaid, then it might make sense to consider other options which could cause less beneficial tax ramifications. The family must weigh the long-term care expenses against the potential tax savings of doing a spousal rollover. This analysis should not be done without the assistance of a certified elder law attorney knowledgeable in tax matters.
Besides naming a primary beneficiary of your IRA, it is also wise to name contingent beneficiaries. These are the people who would inherit your IRA if your primary beneficiary predeceases you or upon the death of the surviving spouse. It is common for people to name their children as contingent beneficiaries of their IRA. Instead of children, or if you don’t have children, you can name other family members, a trust or charity, among others, as the beneficiary of your IRA.
From a financial and tax planning standpoint; it is desirable to keep IRA assets invested as long as possible. Income and gains accumulated inside an IRA are not taxed until the funds are withdrawn. Whereas, assets outside of an IRA are typically taxed each year. Assets inside an IRA will grow faster since they are not depleted by taxes each year. So, the longer assets can remain invested in an IRA, the faster they will grow. In the financial world, this is known as a “stretch” IRA. So, the younger the beneficiary of the IRA, the more it can be “stretched” and the greater the tax advantages. If there is more than one beneficiary, the IRS has convoluted rules for whose age is to be used to calculate the distributions from the IRA. Also, if a charity is named as beneficiary, the ability to “stretch” the IRA will not be available.
Of course, there is no guarantee that the IRA beneficiary will go along with the “stretch.” While not wise from a tax perspective, the beneficiary may withdraw all the funds at any time; even if it causes significant tax consequences. One of the things many of us have learned is that the next generation does not see things the way we do. One way to maintain control over when the beneficiary takes distributions is to make a trust the beneficiary of your IRA; however, the IRS has very strict rules on the types of trusts that will allow you to obtain the tax benefits of “stretching” your IRA. If all the complex rules and regulations are not followed, your beneficiaries must pay taxes on your IRA a lot sooner than you would have wanted. Also, by utilizing a trust as the beneficiary of your IRA, you can provide for the special needs of a beneficiary who is disabled without compromising his government benefits. This type of trust, however, differs from the trust you would use to “stretch” your IRA and will not provide the same tax benefits. In these scenarios, balance the potential tax savings against the possible loss of government benefits by not utilizing a special needs trust.
Confused? You’re not alone. These rules are complicated and there are many traps for the unwary. To do it right, you need someone experienced in tax, trust and elder law matters. With $24 trillion invested in retirement accounts, a lot is riding on getting the proper advice.