Most of us have Individual Retirement Accounts ("IRAs") as part of our estate. During our working years, we focus on how to build our IRA balances and then when we retire, we focus on how much and when we must withdraw from them. However, what happens to our IRAs after we pass away is often overlooked. Without the right planning your heirs can be shortchanged.
One of the major goals of estate planning is to minimize taxation, allowing you to pass as much assets as you can to your heirs. Planning in today's tax intensive environment can be especially difficult with the Federal estate tax exemptions and rates being in a state of flux. However, there are various strategies available to IRA owners that can produce major tax advantages.
By following the rules for payout and beneficiary designations, those with significant IRA balances can achieve tax savings in two major ways. The first is by passing the undistributed portion of a traditional IRA to your spouse. There will be no estate tax due to the unlimited marital deduction and when a spouse is the sole beneficiary, he or she may roll over the funds into his or her own IRA with distributions being made as if the spouse was always the IRA owner, presumably at a time when he or she has retired and is in a lower tax bracket.
On the other hand, when a non spouse is named as the beneficiary of a traditional IRA, the account balance is included in the estate for estate tax purposes subject to the estate tax exclusion allowable in the year of death. Furthermore, distributions will be made over a period not to exceed the beneficiary's life expectancy beginning the year following the IRA owner's death. This is most often at a point in time when the beneficiary is at his or her peak income tax bracket.
The second way to achieve significant tax savings is to pass all gains in an IRA completely free from income tax through the conversion of a traditional IRA to a ROTH IRA. Any income tax which is due because of the transfer should be paid from sources outside the IRA for this strategy to make financial sense. This could be considered a prepayment of the income taxes your heirs would otherwise have had to pay on your death, all without owing any gift taxes or using up any part of your estate tax exemption.
Once the funds have been converted to a ROTH IRA, there are many benefits. The funds now grow tax free and the owner does not have to take unwanted distributions during life, unlike a traditional IRA where the owner must take required minimum distributions by April 1 of the year following the year they turn 70 �. If a spouse is the sole beneficiary, no distributions need to be taken at all. If a non spouse is the beneficiary distributions must begin within five years of the owner's death and be paid out over the beneficiary's life expectancy. If the non spouse beneficiary is fairly young this can mean significant tax free growth. In addition, the distributions (other than the part which is attributable to gains made after the owner's death) are income tax free.
If you would like to lean more, please feel free to contact us for more information.
