When you are being introduced to the benefit program at your first “real job,” you typically get initial exposure to a couple of long-term planning concepts that you may have never considered before. Most packages come with a certain level of life insurance, and you can typically participate in a 401(k) plan to save for retirement.
In many instances, the employer will match your contributions up to a certain percentage. This is nothing more or less than free money that you can receive on a sustained basis for decades if you stay with the same job. You absolutely must take advantage of this golden opportunity.
Many people will plan their retirement with the knowledge that they are going to extract money from their retirement savings account to fund their golden years. This is what it’s all about in general, but if you never need the money, an IRA can be quite useful from an estate planning perspective.
Generally speaking, there are two different types of individual retirement accounts that are utilized: traditional accounts, and Roth IRAs. There are some similarities, and there is one major difference between the two of them. First, we will look at the aspects that are the same.
You cannot withdraw money from either type of individual retirement account without being penalized until you are 59 ½ years old. However, there are a handful of exceptions to the rule. If you are buying your first home, you can extract up to $10,000 to assist with the purchase.
Under the rules governing individual retirement accounts, you can pay school tuition with assets in the account without incurring any penalties. If you have non-reimbursed health care expenses that exceed 7.5% of your adjusted gross income, you are not penalized if you pay them with funds from the account.
Now we can get into the differences. The contributions that you make into a traditional account are not taxed, and this reduces your taxable income. This is a positive when you file your returns, but it all comes back around full circle when you take distributions.
The withdrawals are subject to regular income taxes, and you don’t have the luxury of keeping the money in the account untouched for the rest of your life with estate planning in mind. Because the IRS wants to start getting their cut at some point, you are forced to take mandatory minimum distributions when you are 70 ½ years old.
With a Roth IRA, you pay taxes on the income before you contribute into the account. You do have to wait until you are 59 ½ years old to avoid penalties, but the distributions are not taxed.
The Internal Revenue Service does not require you to take mandatory minimum distributions at the age of 70 ½ or any other age, because they don’t have to try to retroactively collect taxes.
Because of the nature of Roth IRAs, they can be used quite effectively in an estate planning context. The beneficiary (assuming it is not your spouse) would be required to take mandatory minimum distributions upon assumption of ownership of the account. This being stated, the word “minimum” is quite operative here.
The minimum that is required would depend upon the age of the beneficiary; a younger beneficiary could take less than someone that is older, because it is about life expectancy.
Assets in the account will grow consistently if the economy is functioning, so it is wise for the beneficiary to take only the minimum to maximize the tax-free growth for as long as possible. Whenever distributions are taken, they would not be subject to taxation.
We have provided a basic explanation of this concept here, and there is another resource that you can access through this website that takes it to another level. Our firm has established a library of special reports that cover many different estate planning topics. One of them is devoted to this topic, and you can click the following link to gain access: Estate Planning With IRAs.