An individual retirement account can help you enjoy your golden years to the fullest. That said, if you experience a certain level of financial success, you may never need the money in the account. Under these circumstances, your IRA would become part of your estate plan.
Let’s look at the details, including some changes that have been recently implemented.
Traditional vs. Roth Individual Retirement Accounts
The two types of individual retirement accounts that are most commonly utilized are the Roth IRA and the traditional IRA.
If you have a Roth individual retirement account, you pay taxes on the amount you contribute. Because the IRS has been satisfied, when money is withdrawn you (or your beneficiary) would not have to claim distributions as taxable income.
You are allowed to take penalty-free withdrawals when you reach 59 ½ years of age. When you have a Roth account, you are never required to take distributions, and you can contribute to the account indefinitely.
With a traditional individual retirement account, you make deposits before you pay taxes. In other words, pre-tax contributions. The tax on your contribution is deferred until it is withdrawn. As a result, distributions are subject to taxation, and the same penalty-free distribution age applies to these accounts.
A major difference in the two forms of an IRA is the fact that in a traditional IRA you do have to take required minimum distributions when you are 72. This is one of the changes that we alluded to in the opening.
In December of 2019, the SECURE Act was enacted. That law increased the age at which you are required to begin taking distributions from 70 ½ to 72. This measure also gave traditional account holders the freedom to contribute to their accounts for an open-ended period of time.
Before the SECURE Act came along, contributions into a traditional IRA had to stop when the account holder reached the required minimum distribution age.
Rules for IRA Beneficiaries
Now that we have provided some necessary background information, we can get to the inheritance planning implications.
When a spouse is named the beneficiary of an individual retirement account they have the option of rolling the deceased spouse’s IRA into their own IRA. They also have the option of treating the account as an inherited account and become the beneficiary according to the life expectancy of the deceased spouse.
The guidelines are different for non-spouse beneficiaries. Whether it is a Roth or a traditional account, a beneficiary would be required to take minimum distributions. Both are treated as inherited IRAs. The payouts would be taxed if it is a traditional account With a Roth account beneficiaries would not have to report the distributions as income.
Prior to the enactment of the SECURE Act, beneficiaries of individual retirement accounts could implement a very effective “stretch IRA” strategy. This was especially useful for Roth beneficiaries.
They would elect to receive only the required minimum distributions for as long as possible – over their life expectancy, and this would maximize the tax benefits. Now, all of the assets have to be cleared out of the account within 10 years of the passing of the original account holder.
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