Estate-Planning Tip: Stretch Out Your IRA by Choosing the Right Beneficiary
You may be familiar with the benefits of using an individual retirement account (IRA) to build retirement funds. But the tax advantages of IRAs can make them useful estate-planning tools, as well.
If you don't need the money in your IRA when you're retired – or don't need all of it – your IRA can potentially continue to grow tax-deferred for years or even decades beyond your lifetime.
The beneficiary designation on your IRA controls who receives the assets after you're gone, how quickly the assets must be distributed and when and to what degree the distribution will be taxed. The rules governing the treatment of an inherited IRA are complex and depend on whether the beneficiary is your spouse or someone else and if required minimum distributions (for a traditional IRA) began before you passed on the IRA.
A Spouse Has More Options
A spouse has the most flexibility when receiving an IRA inheritance. He or she can "assume" an IRA, transferring the assets into an IRA in his or her own name. In this case, the IRS treats the IRA as if it had always belonged to the spouse. He or she can name a new beneficiary and can put off taking distributions from a traditional IRA until reaching age 70 1/2. A Roth IRA can be left untapped during his or her lifetime.
Spouses and nonspouses alike can take an inherited IRA as a beneficiary. In this case, the beneficiary is required to withdraw from the account over a fixed period of time based on his or her life expectancy. But if a surviving spouse is the beneficiary, he or she also has the option of putting off minimum required distributions until the end of the calendar year in which the account's original owner would have turned 70 1/2 (assuming the original owner died before reaching that age).
If an IRA is left to a charity, estate or trust, the rules are significantly different, because those entities don't have a life expectancy upon which to base minimum withdrawals. Consult a tax professional to explore these options.
Estate-Planning with a Roth IRA
A Roth IRA can help you maximize the amount you leave to heirs. Two features of Roth IRAs come into play:
• Roth IRAs are not subject to minimum-withdrawal rules that apply to traditional IRAs. There is no requirement that you begin withdrawing from your account by the time you reach age 70 1/2. That means you can leave your account untouched to keep growing for your heirs if you don't need the money yourself.
• Withdrawals from a Roth IRA are tax-free for beneficiaries. Your beneficiaries can use every dollar in your Roth IRA income-tax- and penalty-free if you owned the account or at least five years. Non-spouse beneficiaries are subject to minimum distribution rules, however.
Help Is at Hand
Consult a tax professional or attorney to explore how choosing the right beneficiary can help maximize assets for your heirs.