Many factors affect how an Individual Retirement Account (IRA) fits into an estate plan. The rules for implementing a qualified IRA can be complicated, and while the tax consequences can be beneficial, they can also be serious if the account is not implemented correctly. In order to discover how to put IRAs and estate planning together, you will need to look broadly at your income, assets, and your retirement goals, and then work with a qualified estate planning attorney who knows your situation and your goals.
Introduction to IRAs and Estate Planning
The most commonly used IRAs are the traditional IRA and the Roth IRA. A traditional IRA can be used to save for retirement when an employer does not offer other retirement benefits, to accumulate additional retirement money, and to reduce taxable income and defer taxes until retirement when annual income may be lower and taxed at a lower rate. Both traditional and Roth IRAs may be funded each year up to $6,000 (in 2019), subject to some restrictions, or up to $7,000 if you are age 50 or older. More information can be found on this IRS FAQ page. The tax consequences for IRA contributions vary between the two IRA types.
How a Traditional IRA Fits into Your Estate Plan
Traditional IRA contributions are tax deductible, subject to some restrictions, in the year contributions are made. These contributions lower taxable income for the year. Earnings are not taxed until they are withdrawn, when they are taxed at the current year's tax rate. This means that if you are making less money when you retire, you will save money on your taxes in the long run.
Contributions cannot be withdrawn until age 59 1/2 because withdrawals before that age are taxable and subject to a 10 percent early distribution penalty unless they meet certain IRS exceptions. You do not have to withdraw money from the traditional IRA until after age 70 1/2, at which time you must start taking mandatory withdrawals in amounts based on an IRS calculation.
A Roth IRA Serves a Different Purpose in Estate Planning
Roth IRA contributions are not tax deductible, but contributions and earnings are not taxed when they are withdrawn provided they are not withdrawn for at least five years after the first contribution. This means that if you anticipate a higher income during retirement, then a Roth IRA may be a better option.
You never have to take withdrawals from a Roth IRA, but the beneficiary must take withdrawals after your death unless the beneficiary is your spouse. The IRS website provides a comparison chart for traditional and Roth IRAs.
Designating the Beneficiary in IRAs and Estate Planning
Exploring estate planning and IRAs involves more than just choosing the type of IRA. Both IRA types will pass directly to your designated beneficiary upon your death without going through your will or probate.
Just as it is important when creating your will to always designate alternative beneficiaries, it is also important to name an alternate beneficiary of your IRA. If your beneficiary has died and no alternate is named, the IRA will become part of your estate and will go through probate, potentially causing delay and additional expense.
If your beneficiary is a minor or has special needs, you may want to make a trust a beneficiary of an IRA so that you can control the distribution of the assets.
Including IRA Beneficiaries and Trusts in Your Estate Plan
In some cases, it makes sense to name a trust as an IRA beneficiary. An IRA and trusts can work for or against you and your beneficiaries. The tax benefits of an IRA can be lost, and serious negative tax consequences created, if a trust intended as an IRA beneficiary is not drafted by a qualified estate planning attorney.
To name a trust as an IRA beneficiary, the trust must be a real person, not an entity such as a charity, and it may be better to use multiple trusts for multiple beneficiaries. If the goal is to protect the IRA assets, stretch the IRA assets, provide for a minor who cannot legally hold title to the IRA assets, or provide for a person with special needs, a trust may be a proper IRA beneficiary.
Get Help Putting IRAs and Estate Planning Together
There are many issues to consider in determining how to use the benefits of IRAs and estate planning to accomplish your overall estate planning goals. These are complicated further if you are considering including an IRA and trusts.
Anna M. Price of Jenkins Fenstermaker, PLLC, is an experienced estate planning attorney who individuals in the greater Huntington, West Virginia (WV) area identify assets and liabilities and the appropriate tools to meet their estate planning goals. For more information, you can reach Anna to schedule an initial consultation by calling (304) 523-2100 or (866) 617-4736 toll-free by completing her online contact form.