There are many different facets to the estate planning process, and questions arise when you start to ponder the details. With this in mind, if you have an individual retirement account (IRA), you may wonder about the rules for the beneficiary or beneficiaries.
We will provide some clarity in this post, and it is important right around now, because there have been some relatively recent changes that have altered the playing field.
Traditional Individual Retirement Accounts
The traditional account has a tax deferral benefit. You contribute into the account before you pay taxes on the income, so you get a break in the near term. On the other side of the coin, when you take money out of the account, the distributions are subject to regular income taxes.
Since the IRS wants to start getting some money eventually, you are compelled to take required minimum distributions (RMDs) when you are 72 years of age. Prior to the enactment of the SECURE Act at the end of 2019, the mandatory distribution age was 70.5.
You can choose to take penalty-free distributions when you are 59.5 years old. Early withdrawals are subject to a 10 percent penalty, and you would have to claim the distributions on your taxes.
There are some exceptions to the early withdrawal rule. You can use money in the account to cover unpaid medical bills, and distributions can be taken to pay health insurance premiums if you are unemployed.
Withdrawals are not subject to penalties if you utilize the funds to pay higher educational expenses, and you can take out up to $10,000 to help you buy your first home.
Before the SECURE Act came along, traditional account holders had to stop contributing into their accounts when they reached the age of 70.5. Now, there are no age constraints.
The taxation works in the reverse manner with a Roth individual retirement account. You make contributions after you have paid taxes, so distributions are not taxable.
Another difference between the two accounts is the minimum distribution requirement. A Roth account holder does not have to accept distributions when they are 72 years of age. You can leave the assets in the account untouched as part of your estate plan if you choose to do so.
Rules for Beneficiaries
If a spouse is inheriting either type of individual retirement account, they have two options. They can retitle the account as an inherited account, or they can roll it over into their own individual retirement account.
Non-spouse beneficiaries do not have the rollover option, and they are required to take minimum distributions. As you would expect, distributions to Roth account beneficiaries are not taxable, and traditional account beneficiaries must pay taxes on the income.
There was an estate planning strategy called “stretching an IRA” that was widely utilized before the SECURE Act was enacted. Beneficiaries would take only the minimum that was required by law for the maximum amount of time to make the most of the tax benefits.
This was particularly profitable for relatively young beneficiaries of Roth accounts that were very well-funded.
Unfortunately, the stretch IRA is no longer a thing because of a provision contained within the SECURE Act. Now, all the assets must be cleared out of the account within 10 years of the time of acquisition.
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This post underscores the fact that there are finer details to consider when you are planning your estate. When you work with an attorney from our firm to devise your estate plan, all of your bases will be covered in the optimal manner, and your family members will be the beneficiaries.
If you are ready to get started, you call us at 219-865-2285 or 765-767-5225 to schedule a consultation appointment.