Retirement plans such as 401ks, 403bs and traditional IRAs are funded with pre-tax money, grow free of income (but not capital gains) tax and are taxed on withdrawal. When you are gone, your spouse can roll yours over into hers. But leaving them for your heirs requires complying with complicated rules in order to insure that the required minimum distributions can be taken over their lifetimes, not over five years or, worse yet, as a lump sum.
Ways to Save Your Heirs Taxes on Retirement Plan Assets
The main benefit of 401ks, 403bs and traditional IRAs is their ability to defer income taxes. For that to happen, you – and your heirs – must keep hands off the cookie jar. You must keep the tax man’s hands off as well.
Help that happen.
Name a “designated beneficiary” (who must be an individual) or a “see through” trust with more than one designated beneficiary (each with his own subtrust) so that that person can receive required minimum distributions over their lifetime. The designated beneficiary or designated beneficiaries must be determined as of September 30th of the year following the year of your death.1 By December 31 of that year any trust must be funded and irrevocable. The IRS will check to make sure that the “designated beneficiaries” are truly eligible designated beneficiaries and not a charity, estate or trust which is not a “see through” trust. Especially since effecting your “designated beneficiary” designations may involve asking a court to establish a minor’s trust or a special needs trust, your letter to your executor or trustee should include instructions not to delay.
What if you don’t?
If you do not and you die before reaching 70 ½, the money must be distributed over five years. The enormous difference in taxes (and the very real possibility that the extra income will push them into a higher tax bracket) may not only disappoint your heirs, it may cause them to doubt your sanity.
If you do not and you die after reaching age 70 1/2, the money must be paid out based on your life expectancy based on the age at which you died. This is not such a good result either. But hopefully you will have lived a good, long life and the amount, especially if it is split among several children or grandchildren, will not push the recipients into higher tax brackets.
For many people assets such as these are an important part of their estate. An estate plan should consider these assets as well as those passing under a Will.
It’s never too late to plan for your future. Schedule a consultation today. Contact The Garrett Law Firm.
1 26 CFR 1.401(a)(9)-4
Estate planning attorney, Terry Garrett, is a member of the National Academy of Elder Law Attorneys and is active in the Texas and Austin Bar Associations. She graduated with honors from Cornell University. She was on the Dean’s List at Wharton Business School. She earned her J.D. at Columbia Law School, receiving the Parker Award and a Mellon Fellowship.
She assists families of people with special needs, people planning for the retirement years and people administering estates.