TRUST & ESTATE PLANNING

Planning for Generations: Rethinking Retirement Accounts

01.01.2019 - Gerard F. Joyce

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How Your IRA Can Benefit Generations Ahead

Individual Retirement Accounts (IRAs) can play a valuable role in estate planning—allowing you to accumulate tax-advantaged wealth and pass it along to future generations. Gerry Joyce, National Head of Trusts and Estates, answers common questions about weaving IRAs into long-term wealth plans.

Q: What is a “stretch” IRA and how can it be used to pass wealth to future generations?

A “stretch” IRA preserves the account’s tax-deferred status for your future beneficiaries. It also minimizes the distribution requirements that would normally apply if your beneficiaries were to take direct ownership. This allows the assets to be preserved and handed down to future generations, while continuing to grow tax free.

Here’s how it works: Let’s say you name your 25-year-old grandson as the beneficiary of your IRA. When you pass away, your grandson will need to contact the IRA’s custodian to retitle the account. The custodian will change the account’s ownership to reflect both your name as the decedent, and your grandson’s name as the inheritor. This title change makes it an inherited IRA, which can now grow tax free and requires only modest distributions to be taken from the account.

As the beneficiary, your grandson can use as much of the assets as he’d like, but can also take just the required minimum distributions, which would allow the account, based on his life expectancy, to ‘stretch’ to future generations, such as his own children. He can even repeat the cycle by following the same process.

Q: Can a Roth IRA also be stretched?

Yes. In fact, Roth IRAs offer several advantages when it comes to estate planning. Most importantly, you are not required to take distributions from a Roth IRA in your lifetime. And the withdrawals your heirs take will be tax free. Keep in mind that if you leave a Roth IRA to several individuals, it must be split by December 31 of the year following your death. The custodian will retitle each beneficiary’s share and distributions can be stretched out over their life expectancies and to future beneficiaries.

Q: How can I maximize my IRA contributions to get the most tax benefits?

There are several contribution restrictions for both types of IRAs that can make it difficult to make large contributions. First, your contributions must come from earned income—so, you must be working. Second, total contributions are capped at $6,000 a year (or $7,000 if you are over 50). You can allocate an IRA contribution any way you’d like, across traditional and Roth IRAs, as long as you stay within the limits.

In addition, you cannot contribute to a traditional IRA if you are over the age of 70½. There are no age restrictions for Roth IRA contributions; however, your ability to contribute is reduced if your income reaches a certain level, and you cannot make any contributions if your modified adjusted gross income exceeds $137,000 ($203,000 for couples).

Q: Does a “back door” strategy eliminate the income barrier for a Roth IRA?

In many cases, the so-called “back door” strategy is a viable alternative for individuals who want to use a Roth IRA but exceed the income limits. The approach typically involves opening a traditional IRA, which does not have income restrictions, making after-tax contributions (usually called a “non-deductible” contribution since no tax credit or deduction is allowed), and then converting it to a Roth IRA. While there are income limits on Roth contributions, they do not apply to Roth conversions.

But caution is advised if you have deductible and non-deductible IRA assets because the IRS takes all your IRAs into consideration when calculating the tax on any conversion, using its “pro-rata” rule. For non-deductible IRAs funded with after-tax dollars, only the earnings are factored into the tax. But for tax-deductible accounts, all assets are included, even “outside” IRAs. So, be careful when converting an IRA if you have deductible or earnings on non-deductible assets as part of your retirement portfolio.

If you have tax-deductible IRA assets, or earnings on non-deductible assets, there are several steps we can take to mitigate or offset the conversion tax. You can pair the conversion with charitable giving, or it might also be possible to roll those deductible assets into your company’s 401K plan, removing them from the prorata tax calculation. Our retirement team can help you determine the best approach to paying conversion taxes, based on your individual circumstances.

Q: How does a Roth conversion affect estate taxes?

That depends on several variables, including your current tax rate, the size of your estate, and how much appreciation your traditional IRA earned. The good news is that your conversion tax, plus any future appreciation those funds might have earned, is not included in the value of your taxable estate, preventing the “double taxation” of those assets. If the value of your estate is just beyond the exemption limits, and the subtractions are significant enough, they might even bring your estate below the trigger point for the 40% federal estate tax.

Q: Can a traditional IRA be used to reduce estate taxes?

If you own a traditional IRA and don’t want to convert to a Roth IRA, there are two strategies that could help with estate taxes— and they both involve charitable contributions. First, if you are taking required minimum distributions and don’t need the income, you can take advantage of a strategy called Qualified Charitable Distributions. When done properly, this technique allows you to donate your distributions, up to $100,000 a year, to charity. This can reduce your taxable income and remove the assets from your estate. Second, you can leave some or all of your IRA assets to a qualified charity, either in your will or as part of your estate plan. This strategy also reduces the value of your estate, and the charity receives 100% of the assets tax free.

This analysis is provided for illustration and discussion purposes only and does not guarantee future results. Please speak to your Fiduciary Trust contact if you have questions or would like more information. This communication is intended solely to provide general information. The information and opinions stated are as of January 1, 2019, and may change without notice. The information and opinions do not represent a complete analysis of every material fact. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.

CFA and Chartered Financial Analyst are trademarks owned by CFA institute.

IRS Circular 230 Notice: Pursuant to relevant U.S. Treasury regulations, we inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. You should seek advice based on your particular circumstances from your tax advisor.

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