Recently Jess had an article included in the Covenant Investment Advisors Quarterly Newsletter.
The text of the article is below:
How to Make Your IRAs Outlast You
Jess R. Monnette
In previous newsletters, we've discussed the basics of Individual Retirement Accounts, or, IRAs. The tax benefits associated with IRAs (tax deferral for Traditional IRAs, tax-free distribution for Roth IRAs) make these accounts a very powerful investment and savings tool. Although questions regarding eligibility and investment decisions should be referred to your advisor, I want to use this article to explore how an IRA can factor into your estate plan.
In both kinds of IRA, the owner can name his own beneficiary to inherit the IRA at the time of his death. If the beneficiary designation is properly made, an IRA owner can defer income taxes on a Traditional IRA well beyond the time of his death. In a Traditional IRA, IRS rules require that every IRA owner must begin taking "required minimum distributions" (hereafter "RMDs") when he turns 70½. In a Roth IRA, the RMDs do not apply during the Roth IRA owner's lifetime, but RMDs do apply to any person (e.g. their child) who inherits the Roth IRA. RMDs are calculated by dividing your account value by the IRS's Uniform Lifetime Table. For example, the divisor for a 70 year old is 27.4, so if the owner's account balance is $100,000, the RMD for that year is $3,649.64 ($100,000/27.4). Under the IRS table, the divisor gets smaller each year (resulting in a larger RMD), but it never goes to zero. The rationale behind these RMD rules is that Congress wants tax-favored retirement plans to be used for the individual's retirement, not estate-building wealth transfer vehicles.
However, despite this goal, Congress does allow you to pass on your Traditional IRA or Roth IRA to a beneficiary, thus allowing these accounts to continue long after the original owner's death—indeed, potentially all the way to the beneficiary's death. The beneficiary too will have to take RMDs, but, if he is younger, the divisor will be lower, leaving the vast majority of the assets to continue to grow tax-free within the account. Extending tax deferral decades into the future can produce huge investment benefits.
To do this properly requires careful planning, planning that must be done while the IRA owner is still alive and healthy. The planning must include a review of the IRA plan documents to verify that the plan allows for stretch treatment, and a verification that proper beneficiary designations and elections have been made. If, for example, an IRA owner names his "estate" as IRA beneficiary (or he simply fails to list a beneficiary), then his children will not be able to "stretch" the IRA's tax benefits by using their own life-expectancy in the IRS tables. Similar treatment will occur if the IRA owner names a non-qualifying trust as beneficiary of an IRA. Depending on the circumstances, a child may be required to take distributions from the account based on the IRA owner's age (resulting in a faster distribution schedule), or, the IRS regulations may require that the full account balance must be distributed within five (5) years of the IRA owner's death.
There are many significant traps for the unwary when using IRA planning as part of an estate plan—ever-evolving tax law, IRS regulation, and each family's normal growth and change. IRA owners should consult with knowledgeable professionals who can review the IRA Plan documents and provide competent advice (both tax and non-tax) on how to achieve the IRA owner's goals and integrate those into the rest of the estate plan. Finally, every IRA owner should periodically review his IRA beneficiary designations to make sure that his beneficiary designation coordinates with the rest of his estate plan and will accomplish his goals.
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Jess R. Monnette is an attorney at Monnette & Cawley, P.S., in Wenatchee Washington. Jess's practice areas include estate and tax planning. Jess is licensed to practice in the states of Washington and Idaho, he is also licensed before the U.S. Tax Court. Jess holds a J.D. from Regent University, and an LL.M. in Taxation from the University of Washington. The contents of this article are for general information purposes only and are not meant as either legal or tax advice and should not be relied upon as such.
2 "For example, a 38 year-old beneficiary who inherits a $500,000 traditional IRA and withdraws it using the life expectancy method will have $1,696,000 inside the IRA plus $1,432,000 outside the IRA in 30 years; if he cashes out the entire account when he inherits it, he will have (outside the IRA) only $1,470,000. This example assumes an 8% constant investment return for all assets and a 36% tax rate on all plan distributions and outside investment income; projections were prepared using Brentmark Retirement Plan Analyzer® and NumberCruncher® software (Appendix C)." Natalie B. Choate, Life and Death Planning for Retirement Benefits, 7th ed. (Boston, MA: Ataxplan Publications, 2011), 30.
Tuesday, April 21, 2015 at 11:26AM 