It’s important to think about the tax impact of passing on any retirement accounts to one or more beneficiaries. Unlike other inherited assets, retirement accounts can trigger an income tax liability to your beneficiaries when they make a withdrawal from the plan.
Your beneficiary may be able to delay, or “stretch out,” taking withdrawals (in turn deferring the income tax) depending on whether:
The distribution options for an individual beneficiary depend on how you’re related. If your beneficiary is your:
Beneficiaries of an inherited retirement account must also take annual required minimum distributions influenced by whether you reached your required beginning date at your death. If you die before your required beginning date, your plan assets must be distributed within five years of your death unless the benefits are left to a designated beneficiary. A designated beneficiary can withdraw the benefits over the individual’s (or individual trust beneficiary’s) life expectancy.
If you die after your required beginning date, your plan assets must be distributed over your remaining life expectancy (based on IRS tables) or over the designated beneficiary’s life expectancy.
For some people, it may not make sense to name an individual as the beneficiary. In these cases, certain trusts may be considered a designated beneficiary, allowing the withdrawal of the benefits to be based upon the life expectancy of the individual beneficiaries of the trust. These trusts are sometimes referred to as “look through” trusts. The trust must meet the following IRS requirements to qualify:
If a trust meets these requirements, then withdrawals can be based on the life expectancy of the oldest trust beneficiary, or potentially on the life expectancy of each individual beneficiary.
Even though naming an individual as your beneficiary is the simplest and easiest way, sometimes estate planning goals call for using a trust, despite the added complexity. You can still get favorable income tax results by making sure that the trust is structured properly for this purpose. Your estate planning attorney can guide you through making appropriate choices and adding the proper provisions to the trust.
The tax information herein is not intended to be used and cannot be used by any taxpayer for the purpose of avoiding tax penalties. It was written to support the promotion of Advisory Services. Taxpayers should seek advice based on their own particular circumstances from an independent tax advisor.
Examples included herein, if any, are hypothetical and for illustrative purposes only. Individuals should seek advice regarding their specific situation.
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