Pass It On

Ross Menke

BABY BOOMERS ARE retiring every day and Generation X is right on their heels. With this, an increasingly large amount of wealth is making its way into IRAs and Roth IRAs, thanks to rollovers from employer retirement plans.

I’ve found that many folks don’t quite grasp the complexities of such accounts. On the surface, they seem pretty simple: You contribute to an IRA or Roth IRA, receive tax-deferred growth and then gradually withdraw the funds during retirement. Anything that’s left over after your death goes to the listed beneficiaries.

If only it were so easy. As your wealth in these accounts grows over time, you’ll want to review how your assets will be distributed after you die, so the bequests line up with your wishes. Another consideration: Different accounts and assets receive different tax treatment at your death.

As you consider your estate plan, here are four best practices for handling your IRA or Roth IRA:

Review your beneficiaries. If you’ve designated beneficiaries on your various retirement accounts, you likely made those choices when the accounts were first opened—and never changed them. Check your beneficiary designations online or call the financial institution and ask who is listed. The beneficiaries named on your IRA or Roth IRA take precedence over the instructions in your will and any trust documents.

Consider taxes. Who’s getting your assets, your family or a charity? If you’re planning to give to charity at your death, it should be traditional IRA dollars—those that are usually taxable when withdrawn. Why? Charities don’t pay taxes. Meanwhile, leave your family tax-free assets, like life insurance proceeds and Roth IRA dollars. This strategy will maximize the after-tax value of your estate.

Let your beneficiaries stretch. If your heirs inherit a taxable IRA, they’ll want to let it grow tax-deferred for as long as possible. If they cash out the account entirely within a few years of your death, they could generate a lot of taxable income and bump themselves into a higher tax bracket.

What to do? Encourage your heirs to use a strategy called the stretch IRA. With the stretch, your beneficiaries can take required minimum distributions from a traditional or Roth IRA over their life expectancy, rather than being forced to empty the account within five years. (Unfortunately, for IRAs inherited in 2020 and later years, the stretch IRA is no longer an option for non-spouse beneficiaries. Instead, inherited IRAs typically need to be emptied within 10 years.)

Trim your beneficiaries’ taxes. As a retiree, you may be in a lower tax bracket than your beneficiaries, who are likely still in the workforce. By converting a traditional IRA to a Roth, you can potentially pay tax at a lower rate than your heirs would, once they inherited the account.

That said, you should be careful not to pay too much in taxes yourself. If your IRA is sizable, you will want to partially convert the account over many years, instead of all at once, so you don’t end up with too much taxable income in any one year. Not only does this keep you in a lower tax bracket, but also it’ll help hold down your Medicare premiums.

Ross Menke is a Certified Financial Planner. He strives to provide clear and concise advice, so his clients can achieve their life goals. Ross’s previous articles include A Great GiftBad TimingNever Too Late and Head Games. Follow Ross on Twitter @RossVMenke.

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