One of the main reasons IRAs are so popular is their unique tax structure. Most IRA accounts offer potentially tax-deductible contributions and tax-deferred growth. That means you don’t pay taxes on your investment earnings while the funds are in the account. That tax deferral may help your funds grow at a faster rate.
Are you one of the millions of Americans holding assets inside an IRA account? Since its inception in 1974, the IRA has become one of the most popular vehicles for saving for retirement. As of 2013 there were more than 25 million active IRA accounts, holding nearly $2.5 trillion in assets.1
Additionally, IRAs also have beneficiary designations. That means your named beneficiaries can quickly access the funds after you pass away by simply filling out a death claim form. Your loved ones will undoubtedly appreciate being named as beneficiaries on your account, and their share of the funds may provide them with a helpful financial boost.
Unfortunately, though, an IRA death benefit can also come with some unintended consequences. If you don’t plan ahead, your loved ones could face taxes, fees and even delays in the distribution of assets. Below are a few planning steps you can take to minimize financial risks for your IRA beneficiaries:
Review your beneficiaries.
One of the biggest advantages of using an IRA is that the assets avoid probate, which is the legal process for settling one’s estate. Probate often includes tasks such as filing a final tax return, notifying potential heirs, liquidating assets, paying debts and more. The process can be time-consuming and costly, so it’s usually advantageous for your family to minimize the amount of assets that go through probate.
If you fail to name a beneficiary, however, or if your beneficiaries predecease you, your IRA assets will go to your estate. That means the assets go through probate, exposing them to fees and delaying their distribution.
Again, this risk can be easily avoided by checking your beneficiaries regularly. If a beneficiary passes away, be sure to replace that person on your IRA. Also, name contingent beneficiaries to ensure that your funds will pass to an individual and not your estate.
Talk with your beneficiaries about their options.
While your IRA may have offered tax-deferred growth, that tax deferral doesn’t last forever. When you take distributions from the account, you will likely have to pay income taxes on the withdrawal. The same is true for your beneficiaries. Their death claim distribution is considered taxable. If the distribution is sizable, it could push your beneficiaries into a higher tax bracket.
The good news is that your loved ones have options. They don’t have to take the payout in one lump sum. If your spouse is a beneficiary, he or she may be able to simply assume ownership of your IRA, avoiding a distribution altogether. Nonspousal beneficiaries may be able to “stretch” payouts over several years or even their lifetime. The benefit of that strategy is that it spreads out the tax payments and allows some portion of the account to continue growing tax-deferred.
Talk to your beneficiaries and review their options with them. You could even bring them to a meeting with your financial professional so they’ll fully understand their choices. That may help them plan ahead and make informed decisions. Your death may not be a pleasant conversation topic, but it’s too important to avoid.
Take your RMDs as scheduled.
Most types of IRAs have something called required minimum distributions (RMDs), which are mandated withdrawals starting at age 70½. The Roth IRA doesn’t have RMDs, but traditional IRAs and other types do. The withdrawal amount is based on your life expectancy and the balance of your account. As you age, the required withdrawal percentage will likely increase.
What if you fail to take a required distribution? If that happens, the IRS will levy a tax of 50 percent of the missed distribution. If you fail to pay the excise tax, your estate may be forced to pay it. Your heirs can apply for an excise tax waiver, but there’s no guarantee the request will be approved.
Fortunately, this is an easy risk to avoid. Simply take your RMDs as scheduled. If you miss a distribution, make it up as quickly as possible and pay the excise tax. That will eliminate complications for your family after your death.
Ready to take steps to protect your beneficiaries? Let’s talk about it. Harry Hammond in Sarasota can help you analyze your needs and goals, and then develop a plan. Let’s connect soon and start the conversation.
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