Many people use traditional and Roth IRAs to save money for retirement. But it should also be considered as part of a comprehensive estate plan. If you have an IRA account, it becomes part of your net worth and the assets in it can be passed to a beneficiary of your choice. However, an IRA is an asset that typically passes outside the probate process — and these beneficiary designations are separate and apart from a will. Here’s what you should know if you’d like to leave your IRA to heirs or other beneficiaries.
An Individual Retirement Account (“IRA”) allows a person to save money for retirement on a tax-free or tax-deferred basis. There are three main types of IRAs, each of which come with their own distinct advantages:
The type of IRA you choose will depend upon your specific needs and objectives. However, in addition to planning for retirement, you should also factor in any estate planning goals you might have when selecting the account that is right for you.
Spouses have the most flexibility when it comes to what to do with an IRA they have inherited from the other spouse. They may either treat the IRA as if it is their own and name themselves as the owner or they can roll it over into a different account — such as their own IRA account. They might also decide to treat themselves as a beneficiary.
Importantly, if you wish for anyone other than your spouse to be named as the beneficiary for your IRA, you must obtain your spouse’s permission. This is required since California is a community property state. Similarly, if you wish to make any changes to the designation after your spouse was named a beneficiary, they will also need to give their consent.
An IRA is one of the most significant gifts you can pass along to your children, grandchildren, or other beneficiaries. While there are required minimum distributions (RMDs) that must be made each year, a beneficiary can take a lump sum from the IRA at any time. In some cases, the assets in the tax-sheltered account can grow considerably over the course of a decade.
Significantly, with an inherited IRA, the income tax treatment is the same as the original IRA. In other words, traditional IRAs set up with pre-tax dollars or Roth IRAs made with money after taxes have been paid are treated the same way when they have been passed to the beneficiary.
If you have concerns that your chosen beneficiary might be irresponsible with their inheritance, you might consider naming a trust as the IRA beneficiary and making the intended recipient the beneficiary of the trust. This can allow you to control how the assets will be spent, even after your passing. Specifically, a trust allows you to leave instructions to take distributions over the course of your beneficiary’s life expectancy, or a set amount can be designated per month or year. Trust distributions can be made by an adult trustee for the child’s education, healthcare, and living expenses.
A trust might also be a good option if your intended beneficiary is a minor. While a minor cannot inherit an IRA outright, a custodian would need to be appointed until the child reaches the age of majority. Depending on the type of IRA, there can also be tax consequences when you leave it to a minor. Additionally, it’s important to note that RMDs can no longer be stretched out as in the past due to the SECURE Act of 2019. As a general rule, all assets must be distributed within ten years of your passing, but there are exceptions for disabled persons, minor children, and surviving spouses.
Because of the above factors, some may find that a trust is a better vehicle to leave the assets in an IRA to their heirs and chosen beneficiaries.
When it comes to estate planning, it’s crucial to have a skillful attorney by your side to help ensure you meet your objectives and have peace of mind that your wishes will be carried out. Offering knowledgeable counsel and reliable representation, The Law Offices of Rick D. Banks has been helping clients throughout Fresno and the surrounding area with their estate planning matters for over 20 years. To schedule a no obligation consultation, call (559) 222-4891.