Federal law requires that beginning on April 1 of the year after you reach age 70 1/2, you must beginwithdrawing a minimum amount from your non-Roth individual retirement account (IRA) or 401(k) accounts. These withdrawals are called required minimum distributions (RMDs).
But what if you die after age 70 1/2 and before all the account funds have been distributed? In the eyes of the law, death is no excuse not to take RMDs from an IRA or 401(k). Your heirs must take the final RMD before they can take control of the account.
Congress created the rules governing the minimum distribution of retirement plan funds to encourage saving for retirement and to allow retirement assets to build up tax-free during the plan owner's working years. But lawmakers built in provisions so the money wouldn’t simply keep accumulating tax-free forever. The funds you withdraw are treated as taxable income in the year you take the distribution. If you don’t start taking the RMDs from your retirement accounts and pay taxes on the withdrawals, you will face a 50 percent penalty on what should have been withdrawn but wasn’t.
The rules for inheriting an IRA as a spouse are different than the rules for a non-spouse beneficiary, but regardless of who is inheriting the IRA, the heir must take the RMD for the year the account owner died. The full RMD must be taken by December 31 in the year the account owner died, even if he or she died at the beginning of the year. To take the RMD, beneficiaries must contact the custodian of the account and submit a death certificate. If the account owner died before he or she was required to begin distributions, then the beneficiaries do not need to take an RMD.
The money from the RMD will go directly to the beneficiary listed on the account, not the estate. That means it will be taxable income for the beneficiary. If there is more than one beneficiary, it will be split evenly.
To find out the best way to deal with an inherited IRA, contact an elder law attorney.
“In some states, clients are charged court costs and attorney’s fees, based on the worth of their probate assets. Thus, the cost of the administration of the estate increases, as the value of the probate estate increases.”
This is just one of the reasons people think they want a trust: to ensure that the value of their overall estate will not decrease, because of the cost of probate. The most common way to do that is with a trust, says The Houston Chronicle in the article “Elder Law: Which should I have—A Living trust or a will?”
In some states, probate is not an expensive or overly time-consuming issue. Texas, for example, has what is called an independent administration. Executors handle the tasks involved in settling an estate and distributing assets to beneficiaries. As a result, there’s very little court involvement. However, that’s not the case everywhere. In California, the Probate Court closely supervises the entire probate process and no assets can be distributed without the Court’s approval. Further, in California, probate costs are 5% to 7% of the gross value of the estate. For instance, if your estate is $1 million, the probate costs can be as high as $50,000. If you want to avoid probate costs, you should hire an estate planning attorney. An experienced estate planning attorney can tell you whether a trust is right for your estate. He or she can also explain the difference between different types of trusts.
The trust most frequently used to avoid probate, is known as a revocable management trust, living trust or an “inter vivos” trust.
Selecting the best type of trust for each situation is different. Here are some advantages of living trusts:
Avoiding probate. The cost of probate alone is not reason enough to use a trust. However, if your assets are in trusts, you may not need to file an inventory listing your assets with the court. That’s not always required in every jurisdiction, but if it is required where you live, a trust can help keep your asset list private, by ensuring that it is only seen by beneficiaries.
Asset management for incapacity. A living trust goes into effect, while you are alive. If you become incapacitated, an alternate trustee can step in to manage assets, pay bills and ensure that finances are taken care of.
Avoiding probate in another state. If you own out-of-state property, your estate may need to be probated in your home state and in the other state. If you have a living trust, out-of-state parcels of land can be deeded into the trust during your lifetime, thus avoiding the need for probate in another state. After your passing, your trustee can handle the out-of-state property in the living trust.
Administrative ease. There are, unfortunately, instances when Power of Attorney can be challenged by financial institutions. The authority of a trustee is more likely to be recognized, by banks, investment companies, etc.
There are some questions about whether it’s better to have a living trust or a will. The most complex part of having a living trust, is the process of funding the trust. It is imperative for the trust to work, that every asset you own is either transferred into the trust or retitled into the name of the trust. If assets are left out or incorrectly funded, then probate will probably be necessary. This can occur, even if only one single asset is left out.
If an asset is controlled by beneficiary designation, then the trust may not need to be named a beneficiary, should you want it to pass directly to one or more beneficiaries.
Funding the trust becomes complicated, when retirement accounts are involved. Consult with an experienced estate planning attorney, if you want to make the trust a designated beneficiary of a retirement account. This is because very specific and complex rules may limit the ability to “stretch” the distributions form the account.
Using a trust instead of a will-based plan is growing in popularity, but it should never be an automatic decision. An estate planning attorney will be able to explain the pros and cons of each strategy and help you and your family decide which is better for you.
“You’re hoping to leave your loved ones a nice legacy and something that can enhance their financial security or help them achieve special goals. Have you considered how your individual retirement account (IRA) fits into your estate plans?”
Most people use their IRAs (Individual Retirement Accounts) for retirement income. However, a lucky group find themselves not needing the money from their IRA accounts. Instead, the assets become part of a legacy that they leave to heirs. That is why most IRA accounts include the name of a beneficiary who could inherit these accounts, when the owner passes away, reports the Oakdale Leader in the article “Leaving An IRA As An Inheritance.”
If no beneficiary is named, things can get complicated for both the estate and the heirs. If the IRA has a named beneficiary, but the will names someone else to receive the IRA, the beneficiary named in the IRA is the one who receives the asset. The named beneficiary in any account and especially an IRA, supersedes the will, in almost every instance.
Anytime there is a significant event, often called a “trigger” event, like a divorce, marriage or birth, the estate plan and all accounts with named beneficiaries should be reviewed. This is to ensure that the assets go where the owner wants them, and not to an unintended heir, like an ex-spouse.
There are special rules for spouses, where IRAs are concerned. Married couples typically name each other as beneficiaries on their IRAs. A surviving spouse has certain decisions to make, when inheriting an IRA. The IRA may be rolled over into a new or existing IRA in the spouse’s own name. Taking this route depends upon the age of the spouse and the need for the money.
Another option is to convert the inherited traditional IRA into a Roth IRA. However, taxes must be paid on the conversion. It is also possible to transfer the IRA assets into an inherited IRA. An estate planning attorney will be able to explain all the options and how they will work with the surviving spouse’s estate plan.
To maximize the growth of the IRA, children or grandchildren can be named as IRA beneficiaries. They will need to start taking annual Required Minimum Distributions (RMDs) immediately, and the distributions will be taxable. However, the amount of the RMD will be based on their anticipated lifetimes, so the taxable distributions will be relatively small. The money in the account will have many years to grow.
When children or grandchildren are named as contingent beneficiaries, a surviving spouse has the option to disclaim the IRA, which allows the children or grandchildren to inherit the IRA and enjoy the tax-free years of growth.
Many advisors counsel against naming an estate as a beneficiary, because it helps avoid probate and strict distribution time limits.
Up the savings side. Once you’re not spending cash on your kids for clothes, college funds, cars and car insurance, that cash can move into retirement savings. The maximum for a 401(k) in 2019 is $19,000, and if you are over age 50, you can add $6,000 as a “catch-up” contribution. For annual IRA contributions, the limit is $5,000 with a catch-up of $1,000. Increase your paycheck deductions to the percentage, that will get you to the IRS limits. Put savings first.
If there’s a match, don’t miss it. Lucky enough to work for a company that matches all or part of your retirement savings? Do whatever you can to take full advantage of that free money. The most common company match is 50 cents per dollar on 6% of pay, according to Vanguard Group, which says that 70% of 401(k) plans had this match in place in 2017. Let’s say you earn $75,000 and save 6% of your pay. The company would give you $2,250, which means you’d be boosting your savings to $6,750.
Max out savings. The more money that is saved, the faster the nest egg grows. A married couple that socks away a combined $50,000 in pretax dollars every year in their 401(k)s, can find themselves with an additional $250,000 in five years. That’s not counting company matches or any investment growth.
Catch-up as fast as you can. Over 50? The IRS promotes savings by allowing catch-up contributions. An additional $6,000 is allowed in a 401(k). Parents who were paying for summer sleep away camp or riding lessons, can move those dollars into their own retirement accounts.
Control spending. The natural inclination when cash flow loosens up, is to spend more. Many people decide to live it up during these years, feeling like they deserve to enjoy themselves after dedicating so many years to their children. There’s a balance that needs to be found between enjoying and over-spending. Most families increase their retirement savings when the children are gone, but not by enough. Ramping up spending, instead of saving, means years of missed opportunities to build your retirement accounts.
The best advice is to take the long view. Savings instead of putting a convertible in the garage or taking lavish vacations, when a more modest approach is equally enjoyable, could change the nature of your retirement.
“I had never worked with a financial advisor, so I didn’t really understand that there would be a specific age that would come along, regardless of whether or not I was working, and bang, I would have to withdraw this money, whether or not I needed it,” he says.
Once you celebrate your 70th birthday, you may start seeing a lot of notices in the mail from financial institutions about taking withdrawals from IRAs and other kinds of retirement accounts. Those letters are going to arrive, even if you are still working and have no plans to retire, says Money, in an article titled “Don’t Miss This Key Tax Deadline.”
The problem is, the IRS doesn’t care whether you are working or want to start taking withdrawals. It also does not care if you want that money to keep growing tax free. The agreement you made back when you started putting money into those accounts, was that you could contribute pre-tax dollars and deferred paying income tax on that money and any earnings. However, once you turn 70½, Uncle Sam wants his share.
Starting the year that you turn 70½, Required Minimum Distributions or RMDs begin, and you must pay ordinary income taxes on it. The penalty is expensive: you’ll have to pay the IRS half of what you should have withdrawn, so you don’t want to miss this deadline.
A recent survey from Nationwide showed that only 13% of people who are 65 and still working, were able to identify when they will need to start taking RMDs. The RMD is a percentage of your total assets, based on your age and life expectancy. Let’s look at these two general examples: say you are 70½ this year, and you have $200,000 in assets–your RMD is $7,300. If you are 76 and have the same asset value, then you owe the IRS $9,100. Your tax liability for RMDs should be calculated with the help of your estate planning attorney and your accountant.
How you take these distributions could have a big impact on your tax bill. For many people, the RMD bumps them into a higher tax bracket, when they are combined with other retirement income sources. Another question to address is: how will the distribution impact your Social Security benefit?
By the time you start getting those notices in the mail, you should have an idea of what your retirement income will be and how to make the RMDs work within your budget. What is the biggest problem that people run into? They don’t know about these required distributions, or their tax liability, and are suddenly faced with a penalty on top of a tax bill. It’s not a happy surprise.
Roth accounts offer considerable flexibility, since the money you withdraw is post-tax. They are not subject to RMD rules, while the owner is living. RMD rules for Roth 401(k) accounts do apply.
The only way to completely avoid RMD taxes, is to donate the RMD to a qualifying non-profit institution. This is a way to avoid taking the RMD, if you don’t need the income. You will avoid paying any taxes on it. There is a $100,000 annual limit on this generous strategy.
Another strategy if you don’t need the proceeds from the RMD: use the money to open a 529 college fund for a child or grandchild and fund that account. You’ll still have to pay taxes on the RMD, but the college savings account will grow tax free.
The more you can control your RMDs, which means advance planning, the better. This is something that should be integrated with your entire estate plan, which has (or should have) a tax planning component.
“Besides new exercise regimes and attempts at savings accounts, from a legal perspective, the new year is the perfect impetus for tackling life’s perennial to-do list.”
The New Year sees young adult clients calling estate planning attorney’s offices. They are ready to get their estate plans done because this year they are going to take care of their adult responsibilities. That’s from the article “Estate Planning Resolutions for 2019: How To Be A Grown-Up in The New Year” in Above The Law. It’s a good thing, especially for parents with small children. Here’s a look at what every adult should address in the New Year:
Last Will and Testament: Talk with a local attorney about distributing your assets and the guardianship of your young children. If you’re over age 18, you need a will. If you die without one, the laws in your state will determine what happens to your assets, and a judge, who has never met you or your children, will decide who gets custody. Having a last will and testament prevents a lot of problems, including costs, for those you love.
Power of Attorney. This is the document used to name a trusted person to make financial decisions if something should happen and you are unable to act on your own behalf. It could include the ability to handle your banking, file taxes and even buy and sell real estate.
Health Care Proxy. Having a health care agent named through this document gives another person the power to make decisions about your care. Make sure the person you name knows your wishes. Do you want to be kept alive at all costs, or do you want to be unplugged? Having these conversations is not pleasant, but important.
Life Insurance. Here’s when you know you’ve really become an adult. If you pass away, your family will have the proceeds to pay bills, including making mortgage payments. Make sure you have the correct insurance in place and make sure it’s enough.
Beneficiary Designations. Ask your employer for copies of your beneficiary designations for retirement accounts. If you have any other accounts with beneficiary designations, like investment accounts and life insurance policies, review the documents. Make sure a person and a secondary or successor person has been named. These designated people will receive the assets. Whatever you put in your will about these documents will not matter.
Long-Term Care and Disability Insurance. You may have these policies in place through your employer, but are they enough? Review the policies to make sure there’s enough coverage, and if there is not, consider purchasing private policies to supplement the employment benefits package.
Talk with your parents and grandparents about their estate plans. Almost everyone goes through this period of role reversal, when the child takes the lead and becomes the responsible party. Do they have an estate plan, and where are the documents located? If they have done no planning, including planning for Medicaid, now would be a good time.
Burial Plans. This may sound grim, but if you can let your loved ones know what you want in the way of a funeral, burial, memorial service, etc., you are eliminating considerable stress for them. You might want to purchase a small life insurance policy, just to pay for the cost of your burial. For your parents and grandparents, find out what their wishes are, and if they have made any plans or purchases.
Inventory Possessions. What do you own? That includes financial accounts, jewelry, artwork, real estate, retirement accounts and may include boats, collectible cars or other assets. If there are any questions about the title or ownership of your property, resolve to address it while you are living and not leave it behind for your heirs. If you’ve got any unfinished business, such as a pending divorce or lawsuit, this would be a good year to wrap it up.
The overall goal of these tasks is to take care of your personal business. Therefore, should something happen to you, your heirs are not left to clean up the mess. Talk with an estate planning attorney about having a will, power of attorney and health care proxy created. They can help with the other items as well.
“You wouldn't trust your toddler with a pile of cash, right? Well, this estate-planning technique may allow you to safely pass your IRA on to future generations—if you do it right.”
Some of the biggest blunders in IRA distributions come to those who inherit these accounts. On the bright side, if handled correctly, you can structure the distribution, so your children or grandchildren reap the benefits for many years, says CNBC in the article “Leaving an IRA to a loved one? How to avoid a tax bomb.”
Naming a trust as an IRA beneficiary is a good way to protect large IRAs, since it provides some means of control. By naming a trust, you can protect heirs who are minors, vulnerable to creditors, not able to handle large sums of money or disabled. Trusts only need $12,750 of taxable income in 2019 to be subject to the top tax rate of 37%.
If you don’t structure the trust right, you could accelerate the liquidation of the IRA at warp speed.
Most people think of their spouse, when it comes to naming a beneficiary for an IRA. Unless your spouse needs the funds, it’s best to name the next generation. What are the pitfalls? Not all IRA custodians allow you to list a trust on the beneficiary form. The tax code has very specific conditions, when trusts are the beneficiaries of retirement accounts. If you fail to follow the rules, your heirs could face huge tax bills. For a trust to be viable as a designated beneficiary, it must meet a four-step test:
It must be valid under your state’s laws.
It must be an irrevocable trust, or one that will become irrevocable upon your death.
Beneficiaries must be identifiable from the trust document.
The IRA custodian or trust administrator must have received a copy of the trust by October 31 of the year after the death of the IRA’s owner.
The beneficiaries must be people, not charities and not your estate. If your beneficiaries are not people, then your IRA may not have a designated beneficiary. In that case, your heirs can’t stretch the IRA by taking required minimum distributions, based on the longer life expectancy of a child or a grandchild.
Worse—if your trust fails to meet the test, it is subject to the same rules as if there was no designated beneficiary at all. That means it’ll be depleted faster than you may have wished. If you die before you start taking RMDs (70½) then the IRA must be distributed within five years after death. If you die after you start taking RMDs, then distributions pay out over what would have been your life expectancy.
Speak with an estate planning attorney about the type of trust that will work best. There are two to chose from: a conduit trust, which distributes the RMDs directly to the beneficiary, or a discretionary trust, if you’re worried about a child who can’t manage money or who may be indebted to creditors. Note that RMDs are taxable income to the beneficiary when they receive it, but if the distribution is held in the trust, then the trust owes the taxes.
“If everyone saved a decent chunk of their income throughout their career and never dipped into savings to deal with emergencies, all could enjoy a cushy retirement.”
In a perfect world, we’d all have saved enough by age 60 to relax about money and start planning our golden years. However, in reality, says Bankrate.com, most people find themselves rapidly approaching retirement with not nearly enough savings. Some key suggestions are covered in “6 last-minute retirement planning strategies.” No, they’re not as good as a lifetime of steady savings, but they’re better than nothing.
Start saving like crazy. Reduce all discretionary spending and put anything and everything you can, into your retirement accounts. If you’re over 50, you can add a catch-up contribution to your annual IRA limit of $6,5000—giving you a maximum contribution in 2018 of $24,500. If you exceed the limit, put the money into a savings account. Just be sure to save it.
Consider a shift to your investment portfolio. If your investments are all in low interest rate CDs or bonds, you may want to make a change. This could involve modest moves up on the risk scale that could make a difference. Make moderate changes. Big shifts are never a good idea.
Keep working. While you are able to work, you aren’t drawing money from your retirement accounts, so investments have more time to grow. Working longer also gives you more time to add to those funds. Delaying retirement also increases the income you’ll get from Social Security.
Change your retirement budget. If you thought you were going to spend your retirement living high, rethink that. If you don’t have enough saved, you will likely have to cut expenses. If you have, for example, $400,000 saved for retirement and are used to spending $50,000 annually, your savings won’t last much past eight years (ignoring any investment gains).
If you cut your spending in half, your savings will last 16 years, and if your investments do any growing, so will your overall portfolio. If you can’t make that much of a cut, consider part-time employment. Many retirees today are using this time to pursue careers they once considered a hobby, or simply taking lower-paying, less stressful jobs to round out their household budgets.
Sell your home. If you have a lot of equity in your home, consider selling your home and using the proceeds to add to your retirement account. Rent or buy a smaller home or move to an area where home costs are lower. You may also consider a reverse mortgage, which lets you continue to live in the house, while receiving monthly income.
Be sure to protect your retirement accounts with an estate plan that includes a trust, a will, a power of attorney and an healthcare directive. An estate plan is important for all retirees, whether their assets are large or small. A good estate plan can help you qualify for long-term care benefits should you need them one day. Consider it an investment in your future.