Do you have an IRA, 401K or other type of retirement account? First, you should! And, you should also know how these kinds of “tax-qualified” retirement accounts affect your estate plan.
Without getting too much into the nitty-gritty, the gist of a tax-qualified retirement account is that while the account grows and produces income, you don’t have to pay income taxes until you make a withdrawal from the account, or in the case of a Roth account, ever. There are also limits to what you can put in and take out. Without income taxes depleting the funds, more money remains to invest and grow (we call this “compounded growth“). Bottom line – at the end of the day, you’ll have a lot more money sitting in your IRA than you’d get from the same investments sitting in a non tax-qualified account.
When it comes to estate planning for tax-qualified accounts, remember these three points:
- If you name individual beneficiaries directly on the tax-qualified account, the beneficiaries can keep the account tax-qualified; but
- If you name “my estate” or “the Family Trust” or leave the beneficiary line blank, the funds must leave the account, which means paying all the income taxes due, and no more compounded growth; and
- You must name the beneficiary on the form provided by the financial institution, not in your will.
The distinction is that only an individual [human] beneficiary can take the account as an inherited tax-qualified account. Better, if the beneficiary is a spouse, he/she can roll it over into his/her own tax-qualified account.
Or, if there are reasons not to name an individual directly (perhaps a certain human needs someone to manage the account for him because, say, he’s 3), special trusts can work. However, the rules are tricky so you should engage a qualified estate planner to help.
The lesson for the day is to check the beneficiary status on your tax-qualified retirement accounts to be sure that they are up to date, because a mistake in this area can cost your beneficiaries big time.
AN IMPORTANT CAVEAT here: I have explained a VERY complicated area in grossly simplistic terms. This is not intended as legal advice. This post and the information contained herein have been prepared for educational purposes only. The information on this blog does not constitute legal advice, which would be dependent upon the specific circumstances of a particular case. In addition, because the law can vary from state to state some information on this site may not be applicable to you.
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