Can You Use an IRA for Estate Planning Purposes?
An individual retirement account can provide a valuable nest egg during your senior years. However, under certain circumstances, an IRA can also be useful from an estate planning perspective.
Essentially, there are two different types of individual retirement accounts: traditional IRAs, and Roth individual retirement accounts. There are some similarities between them, but there are also some significant differences.
Taxation is at the core of the differences. When you have a traditional individual retirement account, you make contributions before you pay taxes on the income. This provides an immediate tax advantage, and the account can grow in a tax-deferred manner over the years.
When you are 59.5 years of age, you can start to take withdrawals from your individual retirement account without being penalized. With a traditional individual retirement account, you are required to take mandatory minimum distributions when you are 70.5 years of age, so the estate planning benefits are limited on that level.
Plus, you are taxed on the withdrawals, and if you leave the account to a beneficiary after your passing, distributions taken by the beneficiary would be subject to taxation. However, the beneficiary could choose to take only the minimum that is required by law, and in so doing, the tax-deferred growth would be maximized. This is called “stretching” an IRA.
The estate planning benefits are greater if you have a Roth individual retirement account. With this type of account, you make contributions after you pay taxes on the income. Since the IRS already got their money, you are not required to take distributions at any time. You can allow the account to grow throughout your entire life without withdrawing anything if you choose to do so.
We should point out the fact that you are allowed to take penalty free withdrawals when you are 59.5 years of age.
If you leave the Roth IRA to a beneficiary who is not your spouse, the beneficiary would be required to take mandatory minimum distributions. The beneficiary could choose to stretch the IRA by taking only the minimum that is required, and the distributions would not be subject to taxation.
The mandatory minimum distribution amount is based on the life expectancy of the beneficiary, so the younger the beneficiary is, the longer the IRA can be stretched.
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We have provided a basic overview in this brief blog post. If you would like to obtain more detailed information about the estate planning benefits of individual retirement accounts, we have a valuable resource that you can access through this website.
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