It’s Halloween! This is the time for ghosts, witches, and trick or treating. What does Halloween have to do with your IRA? You might be surprised to hear that your IRA may be haunted. How can that be? Believe it or not, actions you take, or don’t take, can haunt your beneficiaries for years down the road.
Many IRA owners think that naming their estate as their IRA beneficiary is a good way to go. They think that they have spent time and money consulting with an attorney to draft the perfect will. All the work has been done. Why not just name their estate as their IRA beneficiary? Wrong move! That can result in scary stuff that can haunt your IRA beneficiaries. If you name your estate as the beneficiary on your IRA beneficiary designation form, your beneficiaries will not be able to stretch distributions over their own life expectancy. They may even have to take a total distribution of the IRA assets in five years. That could be a serious tax hit. There is no way to fix this after your death. To have the maximum stretch options possible, living people or a qualified trust must be named on the beneficiary designation form.
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You’ve decided to get serious about your financial future and want to find a financial advisor to guide your decisions. There’s a lot to consider in creating a comprehensive financial plan.
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Have you inherited an IRA? What type of IRA is it? Your answer will matter a lot when it comes to your tax bill. Inheriting a traditional IRA will have very different tax consequences than inheriting a Roth IRA.
Consider the following example. Let’s say Tom named his three children as beneficiaries of his three-million-dollar traditional IRA. He never made any nondeductible contributions. When his children take distributions from the traditional inherited IRA those distributions will be fully taxable, but not subject to penalty. What if Tom converted his traditional IRA to a Roth IRA more than five years ago? All distributions from the Roth IRA paid to his children would be tax and penalty free. That is a very different result.
If you were named the beneficiary of a traditional IRA, you will most likely face income tax consequences. This is because most funds in traditional IRAs are tax-deferred but not tax-free. Uncle Sam will eventually want his share. Distributions to beneficiaries will be taxable to the beneficiaries in the year taken. You can minimize the tax impact by using the stretch and taking distributions over the longest period of time the rules allow.