Your individual retirement account can serve as a nest egg during your senior years, but you may find that you do not need the resources. Under these circumstances, the IRA will be included in your estate plan, so you should understand the rules for beneficiaries. We will provide an overview in this post.
Traditional Individual Retirement Accounts
If you have a traditional IRA, you direct pre-tax earnings into the account. You get a tax break each year because your taxable income is reduced by the amount of the contributions, but there is another side to the coin.
When you take withdrawals from the account, they are considered to be taxable income. It is assumed that a retiree that is tapping into the account will be in a lower tax bracket at that time.
This being stated, you do not have to wait until you are actually retired to withdraw money from the account without being penalized. You can start to take penalty-free distributions when you are 59.5 years old. The age at which you are compelled to take required minimum distributions is going up to 73 in 2023 under a provision in SECURE Act 2.0.
There is a 10 percent penalty for withdrawals that are made before you reach the age of 59.5, but there are exceptions to this rule.
You can take penalty-free distributions to pay unpaid medical bills or higher education tuition. There is no penalty if you use money in the account to pay health insurance premiums if you are unemployed, and you can take out $10,000 to help finance a first home purchase.
Another change gives a traditional account holder the ability to contribute into the account for any length of time without regard to their age. In the past, contributions had to stop when the account holder reached the required minimum distribution age.
Roth IRAs
The other type of account that is most commonly utilized is the Roth individual retirement account. Everything is the same with regard to the age at which penalty-free distributions of the earnings can be taken. The same exceptions apply, and there is no end date for contributions into the account.
A Roth account holder can withdraw portions of the principal at any age without being penalized.
You make after-tax contributions into a Roth account, and this is the difference. Because the taxes have been paid, you never have to take distributions. If you choose to take money out of the account, the distributions are not taxable.
Rules for IRA Beneficiaries
The tax arrangement is the same for beneficiaries of individual retirement accounts. A Roth account beneficiary would receive tax-free distributions, and distributions to the beneficiary of a traditional account would be taxed.
There was a very effective estate planning strategy called the “stretch IRA” that was widely utilized before the first SECURE Act went into effect in 2020. Beneficiaries would take only the minimum that was required by law for the maximum length of time to take full advantage of the tax benefits.
Younger beneficiaries could stretch IRAs for longer periods of time than their older counterparts. This approach was especially advantageous for relatively young beneficiaries of Roth accounts that were well-funded because of the tax-free distributions.
Unfortunately, a provision contained within the SECURE Act compels the beneficiaries of both types of accounts to clear out all the funds within 10 years of the time of acquisition.
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We have prepared a worksheet that you can go through to gain a better understanding of the estate planning process. This resource is free, so you should definitely take advantage of this opportunity to build on your knowledge.
You can get your copy if you head over to this page and follow the simple instructions.
Need Help Now?
If you have learned enough to know that it is time to work with an attorney to put an estate plan in place, we are here to help.
You can schedule a consultation at our Northwest IN location if you call us at 219-865-2285. Our office in Lafayette can be reached at 765-767-5225, you can fill out our contact form if you would like to send us a message.
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