In January of 2002 the I.R.S. made significant changes to the tax treatment of Individual Retirement Accounts in order to simplify the distribution and inheritance process. While the new rules are not entirely simple, they do include many benefits to those who defer income using IRAs and similar tax deferred vehicles for retirement.
In a nutshell, there are several new strategies to lower your present and future tax obligations by planning ahead. And when inheriting an IRA, you can create a stretch IRA (also known as a beneficial IRA or multi-generational IRA) and defer income taxes on the majority of the account.
When used properly, these new techniques can save families tens of thousands of dollars in taxable income and can also provide lifetime income to future generations. When implemented correctly, A stretch IRA can continue to provide income for a spouse, your heirs or even a favorite charity for several years.
Unfortunately, many consumers may not always be aware of these new retirement plan strategies. While there are different factors that will adjust the distribution of an IRA at passing, it is important to touch upon the most common beneficial plans.
Upon their death, most investors simply want to leave their tax-deferred accounts to a spouse and then their children using all possible income tax advantages that are available.
An IRA owner’s spouse will have the most options with IRA dollars. A surviving spouse can roll the funds over into his or her own name and combine these funds with an existing IRA. If the spouse has not attained the age of 70 ½ then no distributions are required.
A spouse with no need for an IRA inheritance can disclaim the funds and pass them on to the children. If the children are minors, it may be wise to consult an estate planning attorney to protect against a lump sum distribution.
On the other hand, if the spouse has not reached the age of 59 ½ and is in need of income, then he or she might choose to become a beneficiary of the IRA account instead of its owner. At this point the IRA begins to “stretch” over a lifetime.
As a beneficiary, the spouse will be required to take a minimum distribution based on his or her life expectancy. This is advantageous as immediate income is created, but the spouse is not required to withdraw the IRA in its entirety and pay income taxes on the full amount. Thus, a large taxable event will be avoided.
In the event that children (adult or minors) are the beneficiaries of the owner’s IRA, the rules change slightly. While children cannot combine the inherited funds with their own retirement plans, they can choose to stretch the payments based on their own life expectancy.
Children named as beneficiaries have until September 30th of the year following the owners passing to divide the account as stated by the plan. For instance, four siblings named as equal beneficiaries of their mother’s IRA would divide the account into four equal beneficial IRA accounts. At that time, they will take a distribution based on their own life expectancy and continue to defer the majority of the taxable income.
This may be the most valuable aspect of the new rules, especially if your deferred plan is of significant value and your children are wage earners. By stretching the IRA, adult children have avoided losing a much larger portion of the IRA to income taxes. This is advantageous as income taxes have increased recently.
When children only take out their required minimum distribution, (the younger you are, the smaller the distribution) they have avoided entering higher tax brackets on all earned income for that year.
Click here to (See Table 3) for use by beneficiaries to calculate RMD amounts.
There are uniform tables used to calculate distributions for IRA owners and their beneficiaries. If your spouse is no more than ten years younger than you, a single table is used to calculate the required minimum distribution.
(See Table 1) to calculate your RMD once age 70 1/2 has been reached.
A second table is used if your spouse is more than ten years your junior. These tables will determine your required minimum distribution at age 70 ½ based on your life expectancy. (As life expectancy grows, the I.R.S may and has adjusted these divisors in order to reflect the fact that people are living longer.)
With proper planning and advice, a “stretch” beneficial IRA can be an extremely valuable and essential part of your estate plan. It is important to work with knowledgeable a adviser in order to protect IRA dollars from income taxes as well as other market risks.
This way the owner, spouse, and any other named beneficiary can benefit substantially from deferred plans without creating a taxable windfall to the Internal Revenue Service.
We assist IRA owners and beneficiaries in setting up accounts that can be stretched now and in the future. Contact us today for assistance establishing a beneficial IRA account.
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