Estate planning is how most investors ensure their assets go to their heirs and not the IRS. At its simplest, estate planning ensures your assets are titled properly and that your beneficiary forms are in concert with your will, so your intentions for your wealth are met once you’re gone. While most investors expect to spend down their retirement savings, estate planning helps ensure the IRS is not involved any more than necessary.
If you want a non-spouse beneficiary, like your child, niece, nephew, or grandchild, to inherit your IRA, old rules allowed the recipient to take distributions over their lifetime—i.e., stretching it out. This technique was colloquially termed a “Stretch IRA.” The beneficiary would pay taxes on the distributions, but if stretched over a span of 40 years, the tax could easily be minimized with a little planning.
Because tax laws often change, the SECURE Act of 2019 altered the distribution rules for non-spouse inherited IRAs. Non-spouse beneficiaries are no longer required to take minimum distributions, but they generally must deplete the account by December 31 of the 10th year following the original account owner’s death. Fortunately, there are alternatives to the “Stretch IRA” strategy.
If it is purely taxes you want your heirs to avoid, you could convert your IRA to a Roth IRA, paying the tax due on the conversion. Your heirs will inherit your Roth IRA and be able to withdraw the money tax free; however, they are still generally beholden to the 10-year withdrawal window.
Another option would be to use your required minimum distributions to pay the premiums on a life insurance policy. When you pass away, the policy pays out to the beneficiaries income tax-free outside the taxable estate. Beneficiaries may choose how to receive the death benefit: lump-sum, specific income payout, retained asset accounts, or by annuity payments over their lifetime. This option certainly achieves the stretch concept of a Stretch IRA; however, the guaranteed payout is subject to the financial strength and claims-paying ability of the insurer.
You could also distribute your money and invest the after-tax balance in a brokerage account. By investing outside of an IRA, you can often better control the taxable gains and take advantage of favorable long-term capital gains rates. If the brokerage account has a named beneficiary to establish a transfer on death designation, the account should generally pass to heirs outside of your taxable estate. Furthermore, inherited assets generally benefit from a step-up in tax basis, which could eliminate accrued capital gains.
While these methods eliminate or minimize the tax liability for your heirs, they don’t dictate the use the funds. To do that, you may consider funding an irrevocable trust with your after-tax distributions. Generally, you can control how a beneficiary receives the funds. Unfortunately, trusts come with upfront costs, ongoing administrative fees and are subject to complex tax rules.
Overall, if you wish for your retirement assets to pass to a non-spouse beneficiary, how you do it depends on your intentions.
If you have questions about the distribution of your IRA after you pass away, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
Listen to the December 3, 2022 “Henssler Money Talks” episode.
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