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Because of recent legislation, IRA owners and qualified plan participants are looking for alternative ways to transfer their account balances to their children and grandchildren, while reducing the amount the IRS will take. In a helpful client piece you can share, we introduce three proven strategies they may want to consider for protecting or helping to enhance the value they pass to their heirs.
If your objective is to leave as much as possible of your retirement accounts to your heirs, then it’s important that you consider how the recent legislation significantly alters what your heirs may receive.
If you’ve accumulated a nice nest egg in your employer qualified plan and/or IRA as well as developed a significant portfolio of other investments, you may plan to delay taking distributions from your qualified assets until the age when you are required to take money out (now age 72) because this strategy allows your qualified assets to continue to grow on a tax-deferred basis.
Alternatively, if you’re already over the age where you are required to take distributions from your qualified assets, and you are taking money out only because the government requires you to do so, you’re likely just taking the required minimum distribution (RMD) amount so the balance can continue to grow tax-deferred.
In both situations, when your heirs inherit your qualified accounts, they will be hit with a tax bill. That tax bill just got larger because of recent legislation.
Prior to the recent legislation, when an IRA owner died the remaining balance of their retirement account could be distributed to heirs such as children or grandchildren in annual installments over the life expectancy of the beneficiary. The new law completely changed this scenario. Now, most nonspouse beneficiaries must take distributions within 10 years. The difference in the aftertax amount received by the heir can be staggering.
For example, prior to the recent legislation an IRA left to a 40-year old child could be distributed over 45.7 years. If the 40-year old child inherited a $500,000 IRA, the first distribution would be $500,000/45.7 or about $10,941. Depending on the beneficiary’s other income s/he would pay federal income taxes anywhere from no tax (if RMD is the only income) to $4,048. At a 6% growth the inherited IRA would grow to $901,788 in 20 years, even as the child takes annual distributions, and would remain over the $500,000 inherited for most of the child’s life.
The new law completely changed this scenario. Now the child must distribute the entire balance within 10 years. If the child amortized the $500,000 over 10 years with the same 6% growth factor the distribution would be $64,089. That change would push the child into a higher tax bracket with income tax between $7,274 (if RMD is the only income) to $23,713 annually. At the end of 10-years the child will pay between $72,740 to $196,650 more in income taxes and the IRA would be depleted.
PUTTING YOUR IRA TO WORK
That’s why today IRA owners and qualified plan participants are looking for alternative ways to transfer their account balances to their children and grandchildren, while reducing the amount the IRS will take. We introduce you to three proven strategies you may want to consider for protecting or helping to enhance the value you pass to your heirs.