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Spring is a season for cleaning up the garden — planting, pruning and intentionally creating the look and feel you want.
Estate planning is no different.
Each year offers us a fresh an opportunity to step back and review what we have in place — thinking about what has worked best in the past and what we might want to do differently now.
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If your garden is like mine, there is usually one plant that requires special attention — whether it’s more sun or less water.
Within your estate plan, your IRA might be that special plant this year — deserving thoughtful consideration to ensure it thrives both on its own and in harmony with the broader financial and estate plan you’ve created.
What is an IRA?
Broadly, during your earning years, contributions may be tax-deductible and investments grow tax-deferred. Then when withdrawals are made in retirement, they are taxed as ordinary income.
A Roth IRA is also a tax-advantaged account, but the timing of the tax advantage is reversed: There is no tax deduction for contributions, and contributions and earnings may be withdrawn tax-free in retirement.
Because I love a good list, here are five facts to know about IRAs as you think about their unique place in your estate plan.
1. Your IRA and your will
IRA assets generally pass to beneficiaries, but not automatically by the terms of your will or revocable trust. It’s vital that you regularly review beneficiary designations and coordinate them with the rest of your estate plan to ensure your wishes will be carried out.
2. Beneficiary matters
Different kinds of beneficiaries have different taxation and distribution expectations. It’s worth considering these differences when selecting your beneficiaries.
- Spouse beneficiaries. A surviving spouse can roll an IRA into their name and delay required distributions, which provides more flexibility in cash flow, tax and estate planning.
- Non-spouse beneficiaries. Non-spouse beneficiaries need to withdraw the entire IRA within 10 years of the owner’s death. This rule is new as of the 2019 SECURE Act and changed how most heirs inherit IRAs. Review your IRA beneficiaries with these new rules in mind.
- Charities. As charities are exempt from income taxes, they can receive the entire account value, making traditional IRAs a powerful tool for leaving a philanthropic legacy.
3. Traditional IRAs and taxes
Unlike most other inherited assets, traditional IRAs are funded with pretax dollars, and they do not receive a step-up in basis at death.
Therefore, every dollar distributed to heirs is generally taxed as ordinary income, which may reduce the realized value of the inheritance. Unlike traditional IRAs, Roth IRAs are generally income-tax free to heirs, though the 10-year distribution rule discussed above still applies.
4. Look beyond taxes
Because creditor and divorce protections for inherited IRAs differ by beneficiary and jurisdiction, beneficiary structure plays a role in preserving wealth.
Update your trust before naming it as the beneficiary of an IRA. If your trust doesn’t contain specific provisions, the IRA may be subject to distributions that are less flexible and less tax efficient.
5. Coordination is key
IRA planning is not a single decision, but part of a coordinated strategy for your life and legacy. Consider talking to an adviser about your individual and family circumstances, and strategies such as:
With the right advice, we can all make sure our retirement goals, tax strategies and estate planning are brought together into a cohesive plan.
And just like creating that beautiful, healthy garden, IRA planning is most effective when it is well thought out, coordinated and tended. Spring is a great time of year to get started.
