Contributed by: Michele Procino-Wells, Esquire
As more “baby boomers” are retiring and rolling over large 401(k)s and other retirement plans to Individual Retirement Accounts (IRAs), proper tax and estate planning for IRAs has become increasingly important.
Upon your death, the beneficiary of your IRA can take the money out as fast as all of it right away, or as slow as payments over the beneficiary’s life expectancy. If the beneficiary is taking the money out as slowly as possible, the amount she or he has to take out every year is known as the required minimum distribution (RMD). Taking the money out as slowly as possible is known as “stretching out” the IRA.
An IRA that is “stretched” allows the money inside the IRA to continue to grow tax free for as long as possible. The longer money grows tax free the greater the amount received by the beneficiary. For example, let’s take a child age 45 (at the time of his parent’s death) who inherits a $200,000 IRA and withdraws only RMDs. If the IRA grows, from both income and principal appreciation, at the rate of 6% a year, then 30 years later when the child is age 75, the child will have taken over $400,000 in RMDs and still have almost $300,000 left in the IRA to use over his later years or pass down to his children (the original IRA owner’s grandchildren).
To sum it up, the original $200,000 inherited IRA became worth over $700,000 to that family. (And that doesn’t include the future value of the RMDs if they’re placed into an investment account). If we assume the IRA will be worth over $200,000 when the owner passes, or will earn a higher rate of annual return, or will go to a younger beneficiary, that IRA may eventually be worth well over $1 Million!
Your beneficiary may not know about the availability of the stretch and request immediate payment. Once the money comes out of the IRA it is taxable income. If the money comes out all at once, it is likely to be taxed at a very high rate. Perhaps your beneficiary tells the broker to roll the IRA over into his own name. This is the same as cashing in the IRA and then transferring the proceeds into his IRA. If your beneficiary isn’t 59 1/2 yet, he won’t be able to withdraw money out of his IRA to pay the tax without a big penalty. In order to receive the stretch-out, a beneficiary who is not the spouse of the decedent must title the account: “decedent IRA f/b/o beneficiary”.
Instead of leaving your IRA directly to your child, you can create a trust called a “Retirement Account Trust” to be the beneficiary of your IRA. Now, your child should not be able to blow the stretch-out. The trustee can then set up the account correctly. While the Retirement Account Trust is designed to maximize the stretch-out, the beneficiary can take more money out if there is an emergency or just because they want to, especially if the beneficiary is his own trustee.
A Retirement Account Trust is designed to protect your beneficiary’s inheritance from creditors, divorce, disability, etc. and to make sure that the beneficiary gets the most tax free growth from the stretch-out.
For anyone who has IRAs (including those owned by his or her spouse) and/or 401(k) or other retirement plans that total over $200,000 - - a Retirement Account Trust is virtually a “no brainer” decision. Simply stated, the income tax reduction and asset protection planning that this trust now provides may save hundreds of thousands of dollars or more for that IRA owner’s family.