Estate Planning for Retirement Accounts
Part I

Like many Americans, you may have a retirement account such as a 401(k) or conventional IRA.  Because the money in your retirement account has never been taxed before (except in the case of a Roth IRA), your retirement account can pose a special tax challenge for your estate plan.

Overview

Here are a few principles to remember for retirement assets:

• The name of the game is delay—the longer your money stays in the retirement account, the longer it will grow tax-free.
• The IRS will not let the fun continue forever—at some point, the retirement account assets have to be distributed. After you reach retirement age, the IRS will require you to start taking “required minimum distributions,” or RMDs, from the account.  (You may take more if you want to.)
• You will pay income tax on all of the distributions from the account, including the RMDs.
• If you pass away before taking all of the money out of your retirement account, your family will inherit the retirement account and the tax liability. Remember, this money has never been taxed before.  Someone will have to pay income tax on your retirement account assets—you can be sure of that!
• With some careful planning, you can (1) minimize the income taxes your loved ones need to pay, and (2) enable them to delay payment as long as possible.

Before we go any further, a word of caution.  The IRS regulations that apply are unbelievably complicated.  Please treat this discussion as a “30,000 foot” overview, not as a detailed road map or as legal advice specific to your situation.

The Simple Approach—Name Your Loved Ones as “Pay On Death” Beneficiaries

One relatively simple strategy is to name your loved ones as the “pay-on-death” beneficiaries of your retirement account.  For example, assume that Jackie is a single professional with responsible adult children.  She names her family members as beneficiaries of her IRA in the following order:

Primary Beneficiary: Jill and John (Jackie’s adult children), in equal shares.

If Jackie dies but is survived by Jill and John, Jill and John will each inherit 50% of her retirement account. If Jill and John inherit the IRA, it will be divided into two inherited IRAs, one for Jill and one for John.  John’s RMDs will be calculated using his own individual life expectancy.  The same is true for Jill.  This will enable them to delay tax, and allow the assets to grow tax-free, by taking only the RMDs.  Jill will pay tax on her distributions using her own marginal income tax rate.  So will John.

By naming her loved ones as “pay-on-death” beneficiaries, Jackie did them a real favor.  They will be able to delay tax on the retirement account assets for some time.  And, when the time comes to pay, they will get to pay using their individual income tax rates.  If Jackie had allowed the retirement account to pass under her estate—by naming her estate as the beneficiary, or (in some cases) by simply failing to name a pay-on-death beneficiary—the tax outcome could have been much less favorable.

This is a general overview and not to be confused as legal advice. If you would like to speak to Jonathan about estate planning, legal, business or tax matter, please email him at jcw@eastbaybusinesslawyer.com or call him at (925) 217-3255.