IRAs and Estate Planning (Part 1)

As Individual Retirement Accounts (IRA) have become an increasingly popular retirement planning tool, it has become more important to understand their place in the IRA owner’s (“client”) estate plan.¬† One of the most fundamental questions related to IRAs is whom the client will name as beneficiary.

The IRA beneficiary designation should be part of a comprehensive estate plan unique to each individual.¬† There is no standard beneficiary designation that can be advised for all clients.¬† When determining the proper beneficiary designation, consideration must be given to the issues that must be addressed for any and all of the client’s assets, such as planning for estate taxes, multiple marriages or special needs children.¬† Additionally, consideration must be given to issues unique to IRAs, such as the required minimum distribution (RMD) rules.

An IRA is a retirement plan created under the provisions of Section 408 of the Internal Revenue Code.¬† Earning inside a traditional IRA are not subject to income taxes until they are distributed.¬† As the name implies, the RMD rules govern the minimum amount of distributions required annually from an IRA both before and after the client’s death.

The client, or the beneficiary after the client’s death, always has the ability to take distributions larger than the RMD from the IRA, including a distribution of the entire account.¬† However, because of the tax deferral benefits of IRAs, many clients and or prefer the opportunity to take the smallest possible distributions and “stretch” the IRA.

The client’s beneficiary selection may affect how the RMD rules are applied.¬† Consequently, an understanding of the RMD rules is the necessary to select the appropriate beneficiary.

The client must begin receiving distributions from his or her IRA no later than the required beginning date (RBD).  The RBD is April 1 of the year following the year in which the owner attains age 70 1/2.  Although the client has until the RMD to receive the first RMD, he or she must receive RMDs for all successive years by Dec.; 31 of each year.

Clients should be aware of possible tax consequences of bunching the first two RMDs in the same tax year.

Following the death of the client, RMDs will be based on 1) the identity (spouse, non spouse, trust, etc.) and qualification of the beneficiary as a designated beneficiary and 2) whether the client dies before or after the RBD.

A “designated beneficiary” is an individual or a trust meeting certain requirements (qualifying trust), which are discussed later in this article.¬† Neither an estate nor a charity can be designated beneficiary.¬† Determination of the identity of the beneficiary¬† and determination of its status as a designated beneficiary are not required to be finalized until Sept 30 of the year following the death (designation date).

The period of time before the designation date may provide valuable opportunity for postmortem planning by the beneficiary and the professional.  In situations with multiple beneficiaries, distributions may be used to satisfy or eliminate a certain beneficiary that cannot qualify as a designated beneficiary.  This would allow the remaining beneficiary and benefit from further deferral opportunities.  Additionally, estate-planning techniques may be used during this time to provide a more tax-efficient distribution of the IRA.  If a trust is named as beneficiary, this period of time may also provide an opportunity fore the trustee, to use techniques to allow the trust to become a qualifying trust.

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