Inherited IRAs are a Crucial Estate Planning Tool

Significant wealth will pass to the next generation in coming decades. Today's retirees can use their IRA assets as an efficient wealth transfer tool to help assure their heirs of years of additional tax-deferred growth.

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For most people, an Individual Retirement Account, or IRA, serves as a valuable source of retirement income, but it can also be an effective way to pass wealth to future generations.

"Most people believe that an IRA is not an effective way to pass wealth. This is due to a common misconception that an IRA is subject to income tax at death if inherited by a non-spouse beneficiary." says Dan Goldie, a financial. "With proper planning and implementation, non-spouse beneficiaries are able to enjoy decades of tax-deferred growth. This can be a powerful, yet little understood, wealth transfer tool."

Many investors are aware that surviving spouses named as sole beneficiaries are allowed to treat a deceased spouse’s IRA as their own, and roll the assets into their own existing or new IRA. This is desirable because it allows for continued tax deferred growth as well as the choice of a new beneficiary.

Non-spouse beneficiaries do not have the luxury of treating a decedent’s IRA as their own. However, the tax code provides a remarkably attractive option for them; it’s called an Inherited IRA. According to Mr. Goldie, "Non-spouse beneficiaries who inherit an IRA from an account holder who died before his or her Required Beginning Date have the option of taking annual distributions based on their single life expectancy."

If the IRA account holder died after his or her Required Beginning Date, then a non-spouse beneficiary has the option of using the longer of his or her own single life expectancy or the remaining life expectancy of the decedent. Mr. Goldie says, "This is a significant change in tax law, enacted in 2003, that greatly benefits a non-spouse beneficiary who inherits an IRA from an account holder who died after his or her Required Beginning Date. Under the old rules, a non-spouse beneficiary in this situation was forced to use the decedent’s withdrawal rate, resulting in far less tax-deferred growth for the beneficiary."

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Here is an example of how an Inherited IRA could work: Sally is a 40-year-old woman who inherits an IRA from her father in 2004. She calculates her life expectancy based on IRS tables to be 41.5 years in 2005, reducing it by one each year thereafter. In this scenario, she would be required to take minimum withdrawals of approximately 2.41% of the IRA in 2005, 2.47% in 2006, 2.53% in 2007, and so on. In addition to these ongoing distributions, if Sally’s father was taking Required Minimum Distributions when he passed, she would have to take the 2004 amount if her father had not done so.

The minimum withdrawals that Sally must take increase slowly as she ages, but do not become significant until she reaches retirement age herself, when she probably would want the higher income anyway. Through proper planning, Sally’s father has dramatically increased the lifespan of his IRA savings and provided his daughter with additional income and tax-deferred inheritance.

Source: - 08-2004

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