Estate planning isn’t just about designating which assets you want to go to specific loved ones or other beneficiaries. It’s crucial that you think about what kind of tax or other financial impact those inheritances will have on the people to whom you leave them.
Consider individual retirement accounts (IRAs). You typically don’t have to include those in your estate plan because the institutions that hold these accounts let you designate your beneficiaries directly on the accounts. If you haven’t yet done this, you should. Declaring one’s beneficiaries on financial accounts is part of the estate planning process, even though it isn’t a matter addressed in a will, trust or healthcare documents.
Before you determine who will inherit your IRA(s), it’s important to know that while the assets may be a much-needed and appreciated gift for some, they can be a significant tax burden for others. Here’s why.
Where the SECURE Act comes in
A federal law called the Setting Every Community Up for Retirement Enhancement (SECURE) Act stipulates that some inheritors (known as “eligible designated beneficiaries”) have their estimated life expectancy (based on IRS calculations) to take the full distribution (withdrawal) on an inherited IRA. Since distributions are taxed as income, that means they may choose to take only a few thousand dollars a year so that it doesn’t move them into a higher income bracket where they’ll have to pay more taxes.
If someone who’s not an eligible designated beneficiary inherits all or part of an IRA, they have just ten years to take the full distribution. For a small IRA, that’s probably not a problem. But, if they inherit hundreds of thousands of dollars or more in IRA assets, that’s a lot of extra taxable income over the next decade. As such, you may want to leave them other assets that won’t place that tax burden on them and leave your IRAs to those who qualify as eligible designated beneficiaries.
Who is an eligible designated beneficiary?
These are family members and others who are most likely to depend on the assets in a loved one’s IRA for financial support for the rest of their lives. These include:
- Surviving spouses
- Minor children (but only until they reach legal adulthood)
- Any beneficiary (related or not) who’s disabled or chronically ill (including trusts set up on their behalf)
- Any beneficiary who’s less than ten years younger than the decedent
By having experienced legal guidance as you do your estate planning, you can better ensure that your assets provide the maximum benefit to those who inherit them and minimize the risk of unwanted, unintended consequences.