Individual retirement accounts (IRAs) are
typically viewed as retirement planning vehicles. But with increased
contribution amounts and the ability to roll over 401(k) balances
to a traditional IRA, many IRA owners are finding they won't use
their entire balance for retirement. Thus, IRAs are quickly becoming
major estate planning tools. When used for estate planning, the
goal is to extend the IRA's life as long as possible so beneficiaries
can benefit from the tax-deferred (for traditional IRAs) or tax-free
(for Roth IRAs) growth.
For instance, assume you have a large traditional
IRA balance, which includes a rollover from your 401(k) plan.
You don't have to start taking distributions until after age 70
1/2.
Then, you only take required minimum distributions calculated
based on your age. When you die, you leave the IRA to your spouse,
who rolls the balance over to his/her own IRA and names his/her
own beneficiaries, perhaps your children or grandchildren. Your
spouse then delays distributions until age 70 1/2 and then only takes
required distributions. When your spouse dies, your children inherit
the IRA, which can be divided into separate IRAs for each child.
Each child can then take distributions based on each of their
life expectancies. By taking only minimum distributions when required,
the balance can continue to grow on a tax-deferred basis for years
or even decades.
The concept can be expanded further by converting
a traditional IRA to a Roth IRA. Although income taxes will have
to be paid on any amounts that would have been taxable when withdrawn
(e.g., contributions and earnings in a traditional IRA and earnings
in a nondeductible IRA), the income taxes can be paid with funds
outside the IRA, leaving the IRA balance intact. Then, you would
not have to make any withdrawals during your life. Since your
spouse can roll the balance over to his/her own IRA, he/she also
would not have to take withdrawals during his/her lifetime. When
your spouse dies, your heirs would then have to take distributions
over their life expectancies, but those distributions would be
federal income tax free, provided the distributions occurred after
the five-tax-year holding period.
Don't lose sight of the fact that your IRA's
main purpose is to fund your retirement. It should only be used
for estate planning purposes if you don't need the funds for retirement.
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