Inherited IRAs

Some of the most generous provisions of the tax code are those that permit beneficiaries of IRAs and other qualified retirement plans to defer income tax on the plans until time of withdrawal. This allows the IRA or qualified plan to grow significantly more than if it were subject to tax on gains each year.

Another equally generous provision of the tax code permits beneficiaries to withdraw only a minimum amount from IRAs or qualified plans each year. By taking only these ‘required minimum distributions’ a beneficiary can stretch out distributions over the better part of his or her lifetime, resulting in further deferral of income tax on the amount remaining in the plan.

Unfortunately, most beneficiaries fail to take advantage of this latter provision and withdraw all of the IRA or qualified plan funds immediately, thereby losing the significant tax advantages of tax-deferred growth.

A recent Senate proposal would have required that beneficiaries withdraw the entire IRA or qualified plan within five year’s of the plan participant’s death. Fortunately the Senate proposal died upon arrival, but this is an excellent reminder that retirement plans are assets that need proper planning.

A common misperception is that one should not name a trust as beneficiary because it’s overly complicated and doesn’t permit a stretch out. While naming a trust does add a thin layer of complexity, a properly drafted trust not only permits the stretch out but it is the only approach that ensures maximum income tax deferral, if that is your objective.

Unfortunately there is no ‘one size fits all’ answer here. Rather, this is best decided after consultation with professionals who understand these issues.

A recent Wall Street Journal online article titled Inherited IRAs: a Sweet Deal A Generous Benefit for Families Survives a Senate Challenge discusses this issue but takes the overly simplistic approach when it comes to naming a trust as beneficiary of an IRA or qualified retirement plan. The full article is available online at https://online.wsj.com/article/SB10001424052702304587704577335751592771924.html.

This blog (hereafter referred to as “communication”) is designed for general information only. The information presented in this communication should not be construed to be formal legal advice nor the formation of any type or form of attorney-client relationship. Readers of this communication are encouraged to seek independent counsel for advice regarding specific and individual legal issues and should not rely on any information contained herein regarding their specific situation. Circular 230 Notice: In accordance with Treasury regulations, any tax advice contained in this communication is not intended or written to be used, and cannot be used, by any taxpayer or reader for the purpose of avoiding tax penalties or for promoting, marketing or recommending to another party any transaction or matter addressed herein or in any link in this communication.