Tax-deferred retirement accounts are an excellent way for people to build wealth and pass it along to heirs. However, if you die before exhausting the savings you have accumulated, inheriting these accounts can create tax difficulties for beneficiaries.
Speak with a skilled estate tax planning attorney about tax-deferred retirement plans in Coral Gables. A lawyer could help you devise an estate planning strategy to make inheriting your retirement account easier on your heirs.
The most common forms of tax-deferred retirement accounts that people in Coral Gables and elsewhere can use are employer-sponsored 401(k) plans and traditional Individual Retirement Accounts (IRAs). Account holders can deposit pre-tax dollars into the accounts annually, lowering their taxable income for the year. Funds grow and no taxes are due until the account holder begins taking distributions. Bear in mind, there are penalties for most early distributions.
Most account holders begin taking distributions after they retire and are in a lower tax bracket. Account holders must begin taking minimum required distributions (MRD) by April 1 after they turn 73.
The annual MRD is based on the total amount in the account, the life expectancy of the account holder, and the life expectancy of the account’s beneficiary. While an account owner can take more than the RMD, taking less incurs a hefty tax penalty.
Account holders often die before they have exhausted the funds in their tax-deferred accounts. These accounts have named beneficiaries, and the inheritance options available depend on whether the beneficiary is a spouse or a non-spouse.
When the beneficiary is a spouse, they can roll the deceased’s IRA over into a new or existing IRA. Even if the deceased spouse had begun taking RMDs, the surviving spouse need not continue until they have reached age 73.
Sometimes, it makes sense for a surviving spouse to disclaim the inheritance and allow secondary beneficiaries to acquire it. Doing so may be wise when the value of the tax-deferred retirement account would increase the value of the surviving spouse’s estate to a degree that it would become subject to estate tax. A knowledgeable attorney in Coral Gables could explain the implications of disclaiming an inherited tax-deferred retirement account.
Non-spouse beneficiaries of tax-deferred retirement accounts are often the account owner’s children or other younger individuals. The IRS requires most non-spouse beneficiaries who inherit IRAs after 2019 to liquidate the account within 10 years. Because they are taxed as regular income, and these non-spouse beneficiaries may be in their maximum earning years, distributions can impose a considerable tax burden on inheritors.
Account owners can take steps to preserve the benefits of tax-deferred accounts after their death and minimize the tax impact on beneficiaries. An experienced Coral Gables attorney could explain the risks and benefits of various options for managing a tax-deferred retirement plan.
An account owner can use the RMD to pay the premiums on a life insurance policy. Over time, the value of the account to be inherited will decrease, and the cash value of the life insurance policy will rise.
When the account owner dies, if planned correctly, beneficiaries of the life insurance policy inherit the proceeds tax-free. If there is money remaining in the owner’s tax-deferred account, the balance distributed to non-spouse beneficiaries will be smaller, making the tax burden on them lower.
Account owners can establish a trust specifically to hold the proceeds of a tax-deferred IRA. In this case, they would name the trust as the beneficiary of the account and name a trustee to manage it. IRA trusts can be structured so that the trustee pays the RMD to beneficiaries every year. The beneficiaries would then pay tax on their distributions.
Alternatively, an IRA trust can be designed to accumulate the owner’s RMDs until the trustee chooses to make distributions to beneficiaries. This preserves the fund’s tax-deferred status and protects it from creditors.
Many people hold substantial wealth in their tax-deferred retirement accounts. If they die before using the money, there can be substantial tax implications for the account beneficiaries.
If you own one or more tax-deferred retirement plans in Coral Gables, speak with a local estate planning attorney. They could help you develop an estate plan that minimizes the tax impact of your retirement accounts on your heirs. Get started today.
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