If you have an individual retirement account, and you do not need the money yourself when you are a senior citizen, the funds would be part of your estate. With this in mind, you should understand all the details so you can take full advantage of the tax benefits.
Traditional Individual Retirement Accounts
When you have a traditional IRA, the contributions are made before you pay taxes on the income. This is very positive in the near term, because you pay taxes on less income. On the other side of the coin, when you take money out of the account, the distributions are considered to be taxable income.
You are allowed to start making withdrawals from the account without being penalized when you are 59 ½ years old. Otherwise, you have to pay a 10 percent penalty, but there are a few exceptions to this rule.
If you use money in the account to cover unpaid medical bills and school tuition, there would be no penalty, but you would have to pay taxes on the distributions. Another exemption to the minimum age rule allows you to take up to $10,000 out of the account to help finance a first home purchase.
Since the contributions were made before taxes were paid, the Internal Revenue Service wants to get some money eventually. For this reason, you have to take required minimum distributions for the year when you reach the age of 72. You can continue to contribute into the account indefinitely if you choose to do so.
The age for mandatory minimum distributions and the ability to contribute for as long as you want to are changes that were implemented when the SECURE Act was enacted. Previously, the distribution age was 70 ½, and contributions had to end when you reached that age.
The other commonly used individual retirement account is the Roth IRA. There are some similarities, but there are a couple of major differences that have to do with taxation.
You contribute assets into a Roth account after you pay taxes on the income, so you are not taxed when and if you take contributions. Since the taxes have been paid, you are never required to take mandatory minimum distributions, and this is another major difference.
The same age is in place for taking penalty free withdrawals, and the same exceptions apply to Roth individual retirement accounts. You can contribute into a Roth account for as long as you see fit.
Rules for Account Beneficiaries
A spouse that inherits an individual retirement account can retitle it as an inherited account and act as the beneficiary. Another option would be to roll the inherited IRA into their own individual retirement account.
There are different rules for non-spouse IRA beneficiaries. If you inherit a traditional individual retirement account, you would be required to take required minimum distributions. These payouts would be taxable, so you would have to report them when you file your returns.
Prior to the enactment of the SECURE Act, you would be able to stretch out the distributions over an open-ended period of time.
This would maximize the tax deferral, which is beneficial in the long run. Unfortunately, this option longer exists. You are required to clear all of the money out of the inherited account within 10 years.
A Roth beneficiary would also have to take mandatory minimum distributions, and the 10 year rule would apply. However, the distributions would not be subject to taxation.
We are here to help if you would like to discuss your estate planning goals with a licensed attorney. If you take the right steps, you can make sure that you are comfortable throughout your life as you simultaneously craft a suitable legacy to pass along to the people that you love.
You can send us a message to request a consultation appointment, and we can be reached by phone at (434) 971-3025.