Estate planning is more than just deciding who gets your assets. When it comes to Individual Retirement Accounts (IRAs), careful planning can protect your wealth. It can also ease the burden on your loved ones. Without a proper plan, your heirs could face unnecessary taxes and complications.
You'll understand why estate planning for IRAs is beneficial and how to include IRAs in your estate plan. Whether you have a traditional IRA, a Roth IRA, or both, the right steps today can secure a better future for your beneficiaries.
What Does Estate Planning for IRAs Entail?
Retirement planning is actually a significant part of estate planning.
With IRAs, estate planning will decide how your IRA assets should pass to your heirs. It ensures the distribution of your retirement savings is fair and conducted in the way you want after you’re gone.
IRAs have unique rules compared to other assets. Did you know beneficiaries of an IRA must follow specific withdrawal timelines? These rules can affect how much of your IRA ends up in their hands instead of the IRS’s.
There are two main types of IRAs to consider:
- Traditional IRAs: Contributions are tax-deferred, but you pay taxes on withdrawals.
- Roth IRAs: You make contributions with after-tax dollars, and withdrawals are tax-free.
Each type comes with its own benefits and challenges when it’s passed down to your beneficiaries. By including IRAs in your estate plan, you can avoid confusion and reduce financial stress for your family.
Key Benefits of Estate Planning for IRAs
Estate planning for your IRA now can save your heirs money and hassle later. It helps reduce your potential tax burden, so loved ones get the most value from your hard-earned savings.
Here are the main benefits of proper IRA estate planning:
- Tax Savings: With the right plan, your beneficiaries can avoid unnecessary taxes. This is especially important for traditional IRAs, where you pay income taxes on withdrawals.
- Flexibility for Beneficiaries: A solid plan allows heirs to stretch withdrawals over time. This can spread out their tax burden and preserve the account's value for years.
- Roth IRA Advantages: Roth IRAs don’t require heirs to pay taxes on withdrawals. They also provide more flexibility for when beneficiaries take the money out.
Without a plan, your heirs could lose a big chunk of your IRA to taxes and legal complications. Merging your IRAs and estate planning ensures your savings support your family instead of going to the IRS.
Strategies for IRAs and Estate Planning
IRA estate planning isn’t one-size-fits-all. Each decision you make can impact how much of your savings reaches your loved ones.
Here’s a closer look at some strategies:
1. Choose the Right Beneficiaries
Deciding who inherits your IRA is one of the most important steps.
A spouse has the most flexibility. They can roll the IRA into their own account or keep it as an inherited IRA. For inherited IRAs, if the deceased owner was taking RMDs, the spouse must continue them based on the original owner's schedule or their own life expectancy.
If you name children or other individuals, they must withdraw the full balance within 10 years due to the SECURE Act. Proper planning can help spread out withdrawals and lower taxes.
Trusts can be useful if you want to control how the money is used or protect the funds from creditors. But, they add complexity and require careful setup to avoid tax traps.
2. Take Advantage of the SECURE Act
The SECURE Act changed how non-spouse beneficiaries handle inherited IRAs. Most must now empty the account within 10 years. This new rule can create a tax burden if someone has to make large withdrawals in a short time.
Consider strategies to reduce the tax impact, like spreading out conversions to a Roth IRA or withdrawing smaller amounts while you’re alive.
3. Consider Roth IRA Conversions
Roth IRA conversions in estate planning can make moving assets easier for your heirs. Here’s how a Roth IRA conversion works:
- You pay taxes on your traditional IRA balance now.
- Your money moves into a Roth IRA, where it grows tax-free.
- When your heirs inherit the Roth IRA.
This strategy can save your heirs a lot of money. But, it’s not the right choice for everyone. Converting to a Roth IRA for estate planning means paying taxes now. If you’re in a high tax bracket, it might not make sense.
The longer your Roth IRA grows tax-free, the more your heirs will benefit. A conversion may not be worth it if you’re near retirement or don’t plan to leave the account untouched for years.
A Roth IRA conversion is a powerful tool, but it requires careful planning. Talk to a financial advisor and estate planning attorneys to decide if this strategy fits your goals.
Using Roth IRAs in estate planning can be especially advantageous for these reasons:
- Heirs of Roth IRAs don’t pay taxes on withdrawals, which can preserve more of your savings for them.
- If your current tax rate is lower than your beneficiaries’ likely tax rate, a conversion can make financial sense.
- Spreading the conversion over multiple years may help you manage the taxes owed.
4. Use Trusts to Protect Assets
If you’re concerned about how your heirs will use the money, a trust can add a layer of control.
- Trusts allow you to set rules for how and when your beneficiaries access the funds in your retirement accounts.
- They’re especially useful for minors, heirs with special needs, or situations where money management could be a concern.
- However, trusts for IRAs must be carefully designed to avoid immediate tax issues.
5. Review and Update Your Plan
Your estate plan should evolve as your life changes. Major life events like marriage, divorce, or the birth of a child may require updates to your beneficiaries. Potential changes in tax laws, like the SECURE Act, may also call for adjustments. You should review your IRA and estate plan every few years to ensure everything aligns with your goals.
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Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.
The commentary on this blog reflects the personal opinions, viewpoints and analyses of the author, Stewart Willis, providing such comments, and should not be regarded as a description of advisory services provided by Foundations Investment Advisors, LLC (“Foundations”), an SEC registered investment adviser or performance returns of any Foundations client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment, legal or tax advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Personal investment advice can only be rendered after the engagement of Foundations for services, execution of required documentation, including receipt of required disclosures. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Foundations manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Any statistical data or information obtained from or prepared by third party sources that Foundations deems reliable but in no way does Foundations guarantee the accuracy or completeness. Investments in securities involve the risk of loss. Any past performance is no guarantee of future results. Advisory services are only offered to clients or prospective clients where Foundations and its advisors are properly licensed or exempted. For more information, please go to https://adviserinfo.sec.gov and search by our firm name or by our CRD # 175083.
