When you think of IRAs, you probably think of retirement. But what happens to your IRA money after you’re gone? What happens depends on a lot of factors, like how you set up your estate plan, who you choose as beneficiaries, and many other factors. If you do not prepare adequately, your IRAs may not go to where you want or your IRAs may be subject to a tax bill that you do not want.
What your IRA means for your estate plan
IRAs are often a person’s largest asset, or at least one of the largest. When you are creating your estate plan, you have to take your IRAs into account. Every kind of property behaves differently after you pass, and IRAs offer some limited options. It is important to know those options and what fits your needs.
IRAs are subject to income tax after you pass, which your beneficiaries would pay. People often choose their spouse as primary beneficiary, but they have to explicitly name them on IRA documentation, not just assume it will work out that at.
Common IRA mistakes
Probably the most common mistake is not updating your beneficiary designations for your IRA to stay up-to-date with life changes.
Some people name their estate as the IRA beneficiary. This is a problem because in this situation, the IRA has to be distributed out over five years or faster rather than a child’s lifetime. This often results in sooner and larger tax bills and the IRA can no longer grow.
Another mistake is not planning enough if you are giving your IRA to minor children. A guardian can oversee the IRA funds until your children are old enough. If you do not name a guardian, your IRA funds can become subject to court supervision or you may lose control over where your IRA funds go. One option other than a guardian is to name an IRA Trust (or a Standalone Retirement Trust) as beneficiary, which provides long-term suppose and protection for you IRA and minor children.
IRAs and estate and income taxes
Because IRAs are subject to income tax, you need to work with your estate planning attorney to figure out the tax implications of your IRA. You may decide to convert to a Roth IRA or use a life insurance policy and trust to cover estate taxes.
Another option is to use your IRA to contribute to charity, which gives you a charitable contribution deduction. If you have charitable goals, mention this early to your estate planning attorney so you can make the appropriate choice.
Turning even a modest IRA into a huge advantage for your family
A great way to maximize the benefits of your IRA after you pass is to stretch out distributions. This means that your beneficiary can stretch out the time when they will receive distributions, which means smaller distributions and more time for the IRA funds to grow. If you combine stretching out distributions with an IRA trust, you can really maximize how your IRA can grow and bless your beneficiaries over time. This can happen even if your IRA is a “modest” one.