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Your IRA Can Be a Multi-Generational Estate Plan

Over the past 20 years I have advised clients that have inherited individual retirement accounts (IRAs), typically after the passing of a parent. Lately, there has been an increased interest on how to set up IRA accounts to pass directly to children and possibly grandchildren. 

Before we get into the details, let's cover some of the basics regarding IRAs

IRA Basics

  1. An IRA or qualified account can be used to defer taxes over your lifetime (less required minimum distributions (RMDs) past age 70.5), and the remaining balance(s) upon your death can be stretched over each beneficiary’s life (subject to annual RMD).
  2. A rollover IRA account can accept money directly from your employer sponsored 457, 403(b) and 401(k) plans.
  3. A Roth 401(k) can be rolled directly into a Roth IRA. (For related reading, see: Common IRA Rollover Mistakes.)
  4. Multiple traditional IRAs can be combined into one rollover IRA.
  5. Traditional IRAs can be combined into one IRA account and all IRA rollovers can be combined into a separate rollover IRA (Caution: You may give up unique asset protections that a rollover IRA provides (rules vary by state) when a rollover IRA is combined with a traditional IRA).
  6. You must maintain individual accounts; no joint IRAs are allowed.

“Stretching” an IRA can be accomplished by simply limiting the amount withdrawn to the amount of the RMD (it also depends on your investment performance).  Upon your death, the remaining IRA balance can continue to be stretched by naming a beneficiary that has a long-life expectancy (i.e. children, grandchildren, great-grandchildren). (For related reading, see: Want to Leave Money to Your Family? Stretch Your IRA.)

You have three main options for stretching your IRA deferral. Each has increased complexity in set-up (and costs), but generally the more complex options provide you with a more defined outcome.

Generation-Based Beneficiary Designations

A very simple solution is to make a list of all your children, then rank each by age. Your youngest children will be able to stretch out your deferral the longest. Most parents want to evenly distribute the assets among their children. These will be your contingent beneficiaries (your spouse is the primary beneficiary). The allocation percentage is based on the number of children divided into one. List of each of your grandchildren under their respective parents. You then can add your grandchildren “per stirpes,” meaning if your children predecease you the same percentage would be divided among their children. That’s it. The biggest downside to this strategy is that you have zero control over the spending of this money. The other issue is if the parents are deceased when the grandchildren are still minors, a guardian will need to be appointed and a custodial account (i.e. 529 college savings plan, UGMA or UTMA) will need to be established prior to any distributions. 

Conversion to Roth IRA

To maximize growth of your IRA value during your life, you may want to convert your IRAs to a Roth IRA. This increases the upfront costs quite a bit (total value is subject to federal and state taxes as ordinary income in the year of conversion). But depending on how long you live and your investment performance, it could potentially be a big positive (never pay taxes on any distributions from a Roth IRA for life!). The Roth IRA requires no RMD. You will also need to decide if you want to convert your traditional 401(k), 457 and 403(b) accounts into a Roth IRA rollover. I would suggest you hire a financial advisor to perform a Roth conversion analysis so you completely understand any downsides and costs associated to rolling the retirement accounts out of your former employer sponsored plans. The beneficiary designations will be set up the same as in the generation-based beneficiary designation strategy. (For related reading, see: Converting Traditional IRA Savings to a Roth IRA.)

Trusteed IRA

For the maximum desired outcome and control over distributions, this may be the best solution. With a trusteed IRA—or individual retirement trust (IRT)—you can ensure your beneficiary designations can never be changed, restrict the amount of excess distributions (beyond the RMD) and compliment the estate plan between the two of you. Especially if you have set up a QTIP or credit shelter trust. If you want your estate plan and qualified accounts to fully meet your desired outcomes, then this might be the correct choice. The potential downsides are cost to set up and administer, higher tax rates and high minimum balance requirements (minimum balances as high as $2,000,000). This is a more complex account structure and you should seek legal advice and a trustee that is experienced in setting up and administering this account type.

Seek out a fee-only financial advisor that understands these options clearly and can conduct the analysis that I have recommended. Ideally, a financial advisor who is already working with an estate planning attorney in a collaborative relationship and can develop the best solution to meet your needs.

(For related reading, see: Here's How to Use Your Roth IRA for Estate Planning.)

 

The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation. The article was developed and produced by Eric Flaten for educational purposes on a topic that may be of interest. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.

Eric Flaten is an advisor representative of Sowell Management Services, which does business as ePERSONAL FINANCIAL, LLC. Eric is also the founder of ePERSONAL FINANCIAL, LLC, a separate legal entity. Advisory services are offered through Sowell Management Services, a registered investment advisor.