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Should You Make a Child Your IRA Beneficiary?

If you do, there are some “minor concerns” to keep in mind.

Provided by MidAmerica Financial Resources

Should you make a minor child the primary beneficiary of your IRA? Are there any caveats to that choice?

 

IRA owners frequently name young children as contingent beneficiaries of their accounts, but designating someone younger than 18 as the primary beneficiary of IRA assets invites a number of questions.  

 

Will you take advantage of the stretch IRA strategy? Some parents name a child or grandchild as an IRA beneficiary because it just seems like a good thing to do ... without realizing that it could be one of the greatest things they could do to help promote lifetime wealth for that person.

 

If you have plenty of retirement funds apart from your IRA, you may want to consider making your IRA a vehicle to provide for your heirs. The stretch IRA strategy could be a gateway to decades of tax-deferred growth for those IRA assets.

 

When owners of traditional or Roth IRAs die, their beneficiaries have three choices. They can either a) withdraw the money as a taxable lump sum, b) create their own inherited IRA that must be emptied within five years of the original IRA owner’s death, or c) leave the IRA in the name of the deceased owner, and then begin taking Required Minimum Distributions based upon the beneficiary’s age. In this way, RMDs may be stretched over an heir’s lifetime, and the remaining invested assets retain their potential for tax-deferred growth.1,2

 

This last option is the core of the stretch IRA strategy. If the IRA custodian allows, the IRA beneficiary can designate a second-generation beneficiary, the second-generation beneficiary can designate a third-generation beneficiary, and so forth. As long as RMDs are properly made by the beneficiaries, the IRA assets have the potential to keep growing, perhaps for generations. 

 

The stretch IRA strategy is relatively flexible. In most instances, a non-spousal IRA beneficiary can elect to quit stretching the assets at any time by taking the whole remaining balance of the inherited IRA as a distribution. (Some IRA inheritors do run into situations where they need to withdraw more than their RMD.)3

 

What if multiple children are named as primary IRA beneficiaries? This is entirely permissible. If that is the case, then all of their RMDs will be calculated based on the age of the oldest child. Alternately, if the inherited IRA is split into separate inherited IRAs by December 31st of the year after your death, then each of your children may use their own life expectancy to calculate RMDs.4,5

 

What if a minor child inherits an IRA? If the IRA has more than a few thousand dollars in it, then one of two responses may be necessary. If one or both parents are still alive, then they will need to petition a probate court to be appointed guardians of the money. If the child’s parents are deceased, then the probate court may appoint a guardian. If you don’t want to risk any of this happening, you have the authority to appoint a custodian for the IRA per the federal Uniform Transfers to Minors Act (UTMA), which 48 of 50 states recognize. This adult custodian can be named as the IRA beneficiary and will gain the authority to manage the IRA assets.1,5

Keep in mind that the child is free to control and potentially liquidate that IRA at age 18 or 21 (it varies per state and whether or not a custodian has been appointed as an IRA beneficiary).1,6

 

Should you set up a family IRA trust? If you want more control, instead of naming a child as the primary beneficiary of your IRA, you could a) name a qualified see-through trust as the primary IRA beneficiary and b) name the child as the primary beneficiary of that trust.

 

When you pass away, a) the balance in your IRA is then transferred to an inherited IRA, b) RMDs are paid from the IRA into the trust, and then c) payments are made to the trust beneficiary. This way, you can see that the IRA account balance is paid out over an extended number of years, lessening the risk of the child spending the money all at once. If a trust is designated as a primary IRA beneficiary, the resulting RMDs will be based on the life expectancy of the oldest trust beneficiary minus one year.1,2,4

 

There is a definite downside to this. The trust beneficiary (your child) can’t subsequently roll over the trust assets into an IRA and name his or her own beneficiaries. So this is basically “the end of the trail” for a stretch IRA strategy. The payments out of the trust to the trust beneficiary are fully taxable, presuming they are simply passed through the trust to the beneficiary.2

 

Who would oversee such a trust if the child’s parents die? A family IRA trust should name a successor trustee. Assuming a parent is named as trustee, the successor trustee (commonly a younger, financially literate relative) can become the trustee. If a bank, trust company or attorney is the named trustee, they will name a successor trustee. There is nothing preventing a custodian appointed as a trust beneficiary per UTMA from being named as a successor trustee.1,7

 

How will the RMDs be handled? Again, the named primary beneficiary has three options: a lump sum payout (fully taxable), RMDs based on life expectancy (the stretch IRA option), or creating their own inherited IRA that must be emptied within five years of the original IRA owner’s death (an option available if the original IRA owner passes away prior to age 70½).7

 

Assuming the stretch IRA strategy is chosen by the beneficiary, the younger the primary beneficiary is, the smaller the RMDs will be (per the relevant IRS life expectancy tables).

 

If you have not created a family IRA trust, then the primary beneficiary of your IRA will have full control of the IRA assets after your death. It is entirely up to the primary beneficiary to choose or reject a stretch IRA option.7

 

What if you are unsure about naming a minor child as a contingent IRA beneficiary? You could opt to incorporate a disclaimer provision into your beneficiary designations. This will allow the primary beneficiary of the IRA (presumably, your spouse) the option to disclaim his or her interest in the assets, so that they may be claimed by one or more contingent beneficiaries. In this way, you give your spouse (or whoever is the primary beneficiary) a chance to reconsider the initial vision for the inheritance of the IRA assets.8

 

Lastly, if you name a minor child as your primary IRA beneficiary, you should strive to see that he or she gets professional guidance for the invested assets and that the IRA is administered properly over the years.

 

MidAmerica Financial Resources may be reached at 618.548.4777 or greg.malan@natplan.com.

www.mid-america.us

 

This material was prepared by MarketingLibrary.Net Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. Stretch IRAs work best for investors who will not need the money in their IRA account during their lifetime for their own retirement needs

 

    

Citations.

1 – www.nolo.com/legal-encyclopedia/naming-non-spouse-beneficiary-retirement-accounts.html [2/6/13]

2 – www.forbes.com/sites/advisor/2011/06/28/7-mistakes-with-stretch-iras/ [6/28/11]

3 – www.investopedia.com/articles/retirement/04/070704.asp#axzz2KALy628B [6/22/10]

4 – www.theslottreport.com/2012/04/minor-beneficiaries-q-and.html [4/11/12]

5 – fa.smithbarney.com/public/projectfiles/9ecae891-2c7b-4eef-985f-b65412c55589.pdf [9/10]

6 – smith-condeni.com/index.php?option=com_content&view=article&id=74&Itemid=5 [1/31/13]

7 – www.tomboumanlaw.com/IRA_Protection_Trusts_-_FAQ.pdf [2/7/13]

8 – www.investopedia.com/articles/retirement/03/041603.asp#axzz2KALy628B [7/20/11]


A Roth IRA’s Many Benefits

A Roth IRA’s Many Benefits

Why do people choose them over traditional IRAs?

 

Provided by MidAmerica Financial Resources

 

The IRA that changed the whole retirement savings perspective. Since the Roth IRA was introduced in 1998, its popularity has soared. It has become a fixture in many retirement planning strategies, because it offers savers so many potential advantages.   

 

The key argument for going Roth can be summed up in a sentence: Paying taxes on your retirement contributions today is better than paying taxes on your retirement savings tomorrow.

   

Think about it. All other variables aside, would you like to pay the taxes now or wait until retirement?

 

What if federal tax rates are higher in the future than they are today? Would you like to see a) your retirement savings taxed at those higher rates tomorrow, when you may have medical bills or other emergency expenses to contend with, or b) have the dollars you are saving for retirement today taxed at possibly lower rates?

 

Here is a closer look at the trade-off you make when you open and contribute to a Roth IRA – a trade-off many savers are happy to make.

 

You contribute after-tax dollars. You have already paid federal income tax on the dollars going into the account. But in exchange for paying taxes on your retirement savings contributions today, you could potentially realize great benefits tomorrow.1

  

You position the money for growth. Roth IRA earnings aren’t taxed as they grow and compound. If, say, your account grows 6% a year, that growth will be even greater when you factor in compounding. The earlier in life that you open a Roth IRA, the greater compounding potential you have.2

   

You can arrange tax-free retirement income. Roth IRA earnings can be withdrawn tax-free as long as you are age 59½ or older and have owned the IRA for at least 5 years. (That 5-year clock starts on January 1 of the tax year in which you make your initial Roth IRA contribution.)3

 

The IRS calls such tax-free withdrawals qualified distributions. They may be made to you, to your estate after you are deceased, and/or to a beneficiary. (If you die before the Roth IRA meets the 5-year rule, your IRA beneficiary will see the IRA earnings taxed until it is met.)4

 

If you withdraw money from a Roth IRA before you reach age 59½, it is called a nonqualified distribution. If you do this, you can still withdraw an amount equivalent to your total IRA contributions to that point tax-free and penalty-free. If you withdraw more than that amount, though, the rest of the withdrawal may be fully taxable and subject to a 10% IRS penalty as well. (If you are younger than 59½ and have owned a Roth IRA for at least 5 years, you are allowed to withdraw 100% of your contributions and up to $10,000 of IRA earnings tax- and penalty-free to buy a principal residence, assuming the buyer has not owned a home within the past 2 years.)1,3

  

You never have to make a withdrawal. When you own a traditional IRA, you must start pulling money out of it in your in your seventies. These withdrawals are called Required Minimum Distributions (RMDs), and the amount is calculated for you using an IRS formula. These forced withdrawals saddle some traditional IRA owners with tax problems. In contrast, Roth IRA owners never have to take RMDs. They are never required to take a penny out of their IRAs.1

    

Withdrawals don’t affect taxation of Social Security benefits. If your total taxable income exceeds a certain threshold – $25,000 for single filers, $32,000 for joint filers – then your Social Security benefits may be taxed. (These limits are not adjusted for inflation, incidentally.) An RMD from a traditional IRA represents taxable income, and may push retirees over the threshold – but a qualified distribution from a Roth IRA isn’t taxable income, and doesn’t count toward it.5   

 

You can direct Roth IRA assets into many different kinds of investments. Invest them as aggressively or as conservatively as you wish – but remember to practice diversification. The range of investment choices is often broader than that offered in a typical workplace retirement plan.1

 

You can shift dividend-producing investments into a Roth IRA from a taxable account. As dividends are being taxed at higher rates in 2013, keeping dividend-producing investments out of a taxable account has definite virtues.

 

You can potentially “stretch” the assets. If an original Roth IRA owner passes away after owning the IRA for at least five years, then its earnings can be withdrawn tax-free by its beneficiaries. (Relevant estate taxes may need to be paid, of course.) If a Roth IRA beneficiary is not a spouse, then other factors come into play: that beneficiary cannot contribute to the inherited Roth IRA, or combine it with an IRA he or she owns. The non-spouse beneficiary can decide to a) receive a distribution of 100% of the inherited Roth IRA assets by December 31st of the fifth year following the year of the IRA owner’s death, or b) receive periodic payments from the IRA over the course of his or her life, an option which may potentially be “stretched” (given proper planning) and extended to subsequent beneficiaries.6 One important note: stretch IRAs typically work best if you will not need the money in your IRA account for your own retirement needs.

 

 

You have 16 months to make a Roth IRA contribution for a given tax year. For example, IRA contributions for the 2012 tax year may be made up until April 15, 2013. While April 15 is the annual deadline, many IRA owners who make lump sum contributions for a given tax year make them as soon as that year begins, not in the following year. Making your Roth IRA contributions earlier gives the funds in the account more time to grow and compound with tax deferral.1

 

Who can open a Roth IRA? Anyone with earned income (and that includes a minor).1

  

How much can you contribute to a Roth IRA annually? The 2013 contribution limit is $5,500, with an additional $1,000 “catch-up” contribution allowed for those 50 and older. (The annual contribution limit is adjusted periodically for inflation.)7

 

You can keep making annual Roth IRA contributions all your life. You can’t make annual contributions to a traditional IRA once you reach age 70½.7

 

Does a Roth IRA have any drawbacks? Actually, yes. One, you will generally be hit with a 10% penalty by the IRS if you withdraw Roth IRA funds before age 59½ or you haven’t owned the IRA for at least five years. (This is in addition to the regular income tax you will pay on the funds withdrawn, of course.) Two, you can’t deduct Roth IRA contributions on your 1040 form as you can do with contributions to a traditional IRA or the typical workplace retirement plan. Three, you might not be able to contribute to a Roth IRA as a consequence of your filing status and income; if you earn a great deal of money, you may be able to make only a partial contribution or none at all.3,7

 

Rollovers are permitted if you make too much to contribute. Even if your income prevents you from funding a Roth IRA, you can still roll traditional IRA assets into a Roth with the help of a financial professional. While this is a taxable event, you may realize significant long-term financial benefits as a result of it – tax-free retirement income withdrawals, and the potential for some of the Roth IRA assets to pass tax-free to your heirs with further growth and compounding. You also will gain the relief of never having to take an RMD each year.8   

 

All this may have you thinking about opening up a Roth IRA or creating one from existing IRA assets. A chat with the financial professional you know and trust will help you evaluate whether a Roth IRA is right for you given your particular tax situation and retirement horizon.

 

MidAmerica Financial Resources may be reached at 618.548.4777 or greg.malan@natplan.com.

www.mid-america.us

 

This material was prepared by MarketingLibrary.Net Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. Please note - investing involves risk, and past performance is no guarantee of future results. Diversification cannot ensure a profit or protect against loss. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

 

Citations.

1 – www.kiplinger.com/article/retirement/T046-C006-S001-8-reasons-you-need-a-roth-ira-now.html [4/5/12]

2 – www.nj.com/business/index.ssf/2013/01/biz_brain_are_roth_iras_really.html [1/21/13]

3 – www.smartmoney.com/taxes/income/when-roth-ira-withdrawals-arent-taxfree-1293571638217/ [12/29/10]

4 – www.hrblock.com/free-tax-tips-calculators/tax-help-articles/Retirement-Plans/Early-Withdrawal-Penalties-Traditional-and-Roth-IRAs.html [1/2/13]

5 – www.investmentnews.com/article/20121216/REG/312169988 [12/16/12]

6 – www.investorguide.com/article/11816/understanding-the-tax-ramifications-of-an-inherited-roth-ira/ [1/8/13]

7 – www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics-IRA-Contribution-Limits [11/28/12]

8 – www.boston.com/business/personalfinance/articles/2012/05/20/roth_ira_conversion_not_for_everybody/ [5/20/12]    





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