Recently the I.R.S. made significant changes to the tax treatment of Individual Retirement Accounts.
While the new rules are not entirely simple, they do include benefits to those who defer income using IRAs and similar tax deferred vehicles for retirement.
In a nutshell, there are now different 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 72 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 the owner’s life expectancy.
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.
New rules and regulations allow the spouse to withdraw all funds over a ten year period of time if s/he does not want to take them over a life expectancy.
In the event that children (aka Eligible Designated Beneficiaries) inherit a parent’s IRA, the rules change. 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.
Annual distributions are determined by the child’s age in the calendar year following the passing of the parent. Distributions are then spread over the child’s single life expectancy.
However, if the Eligible Designated Beneficiary is a minor, the life expectancy option is no longer available. In this case, the IRA must be distributed over ten years. It used to be that minor children could withdraw funds over their life expectancy, but the SECURE act changed that rule.
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.
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.
There are only a few non-qualified (post-tax) accounts that allow you to stretch the inherited funds. Annuities are one of them, but not all companies offer these products.
IRS rules allowed for this change more recently. This is how it works:
If you inherit a non-qualified annuity with significant deferred gains, you can purchase (or 1035 exchange) it for one that pays-out over your life expectancy. This has always been the allowed with spouses, but not children can take advantage as well.
This helps avoid a one-time, lump sum distribution and immediate tax hit. It can be much more advantageous for working adult children in higher tax brackets to reduce their taxable income by spreading the distributions out over a lifetime. This also provides for guaranteed annuity income later in life as well. It can be a win/win when executed properly.
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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