What happens when your retirement savings outlive you?
What happens when your retirement savings outlive you? Individual Retirement Accounts can be used for your retirement and passed on to beneficiaries you choose after you pass away. Inheriting retirement plan assets is different than inheriting a brokerage account because the beneficiary may recognize income when the assets are distributed from the retirement plan account. With a little planning, the retirement plan balances and the unique characteristics of retirement plans can pass to the beneficiaries. What a wonderful inheritance!
Individual Retirement Accounts (IRAs) are classified as Traditional IRAs or Roth IRAs. Traditional IRAs are tax-deferred while the funds stay in the account. Distributions are taxed as ordinary income. Distributions can generally start at age 59 ½ and are required when the owner or beneficiary reaches age 70 ½; then, a small percentage of the account is distributed annually. Penalties apply if distributions are either made prior to age 59 ½ or if distributions are not made when the beneficiary reaches age 70 ½.
Roth IRAs are tax-deferred as well but if certain conditions are met, distributions are tax-free, meaning the earnings are not taxed! Roth IRAs do not have required minimum distributions when the owner turns 70 ½ like a Traditional IRA. If the funds are not needed right away, the assets can grow for a certain amount of time after the death of the owner.
Business owners or employees can have a SEP-IRA or a Simple IRA. These plans can be transferred into a Rollover IRA after death, but consult with a qualified CPA before moving the account.
When the owner of an IRA passes away, the assets are passed to those beneficiaries designated by the decedent. The designated beneficiary has several options: 1) withdraw funds from the Traditional IRA and pay tax on the distributions in one year or over several years (funds withdrawn from a Roth IRA are generally tax-free); 2) if the designated beneficiary is a spouse, the account can be rolled over into a spousal IRA and tax deferral continues until the spouse is either eligible or required to withdraw funds; and 3) distributions can be made ratably over the beneficiary’s life expectancy, and tax deferral continues because the funds stay in the account and penalty-free distributions can start even if the beneficiary is under 59 ½. These are only a few options and any option should be discussed with a qualified CPA due to the complexity of the calculations and re-titling of assets.
Saving for retirement is the first step to achieving retirement goals. If the decedent established the account, the best option is to name designated beneficiaries on the account to continue the income tax deferral after death. Careful beneficiary designation can avoid headaches after the owner’s death and such designations should be periodically reviewed in light of changing circumstances. Although designated beneficiaries may need distributions after death, the goal is to have the lowest possible required distribution to limit the taxable income the beneficiary is required to recognize.
Disclaimer: Any written tax content, comments, or advice contained in this article is limited to the matters specifically set forth herein. Such content, comments, or advice may be based on tax statutes, regulations, and administrative and judicial interpretations thereof and we have no obligation to update any content, comments or advice for retroactive or prospective changes to such authorities. This communication is not intended to address the potential application of penalties and interest, for which the taxpayer is responsible, that may be imposed for non-compliance with tax law.