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Get some pointers on how to minimize taxes and maximize retirement benefits in your estate plan.

Personal finance

Tax-Smart Tips for Handling Your IRA and Estate Plan

  • 11/21/2014

Most people have some type of qualified retirement account as part of their personal net worth. Some common retirement savings vehicles include, among other things, profit-sharing plans, 401k plans, pension plans, and individual retirement accounts (IRAs). This article will point out some tips to consider when planning to maximize the benefits of these accounts in your estate plan.

Explore our collection of trust and estate planning articles to help you build the financial future you envision.

Following the general rule, most qualified retirement account owners must begin annual required minimum distributions (RMDs) when they turn 70.5. For some couples, this is a source of retirement cash flow while others don’t consider annual distributions a necessity. But Congress decided the taxation of these accounts must occur at some point, hence the RMD rules.

If you don't need the cash flow from the annual distributions, consider converting some or all of your account to a Roth before your RMD date. A Roth allows you to set aside after-tax income, and there are two main benefits to this retirement approach:

  1. Roth IRAs do not have a RMD during the owner’s lifetime
  2. When the owner converts a retirement plan to a Roth and pays the conversion income tax from other fund sources, the Roth IRA continues to grow tax free.

The designated beneficiaries (e.g., children and grandchildren) must start RMDs after your death but generally NONE of the distributions are taxable income.

Beneficiary designations could hinder or help

Certain beneficiary choices can unnecessarily accelerate distributions and related income tax, so be sure to review your designations with a professional advisor. Naming your loved ones as beneficiaries allows for the best options to defer taxation of benefits by “stretching” the retirement plan money over their life expectancy.

That rule changes if an estate or non-qualifying trust is a designated beneficiary of your account. In that case, a special rule requires the benefits to be entirely distributed within five years of the account holder’s death, expediting the taxation of those dollars. Speeding up the taxation of the account’s accumulated benefits can needlessly increase income tax costs and perhaps push recipients into higher tax brackets.

Generally naming your estate as beneficiary of your retirement account will cause acceleration of distributions and taxation of your benefits over a five year period or less. And naming your revocable trust as beneficiary may not necessarily get you the answer you are looking for.

Qualified trusts

Qualified trusts are a bit of a different story. Certain trusts can qualify as a designated beneficiary for the “stretch” period of distributions if they meet the following criteria:

  • the trust is valid under local law;
  • the trust is irrevocable or will, by its terms, become irrevocable upon the death of the individual; and
  • the trust beneficiaries are all individuals who are identifiable from the trust document.

Generally, the oldest individual trust beneficiary’s life will set the period for the distributions from the retirement account. Trusts can be useful for certain goals but do add a level of complexity that may not be needed.

Review your objectives for your retirement plan assets before setting up these complex strategies. Be aware of the income tax implications of common estate planning strategies during your review (e.g., non-grantor trusts), along with the nonfinancial planning aspects of a trust.

Charitable giving and contingent beneficiaries

A charity can be a perfect beneficiary for some or all of a retirement account (other than a Roth IRA). Assets that go directly to aid charitable organizations are not taxable for income tax purposes or taxable for estate tax purposes. For those with larger estates and retirement plan accounts, having a tax exempt entity as the beneficiary of a portion of the account can be very tax efficient.

A word of caution: if your favorite charity is a partial beneficiary of a retirement account, it is important the charitable portion be paid out in a defined time period after the account owner’s death. That way, individual beneficiaries may have the benefit of “stretching” the retirement account balances over their lifetimes.

Finally, check your contingent beneficiary designations to allow for disclaimer planning and to prevent an estate from becoming a beneficiary by default.

How we can help

This article only touches on a few concepts for retirement accounts and estate planning. We encourage you to consult with your CPA and/or wealth advisor for a more thorough review of options and opportunities as part of a well balanced estate plan.