6 Important Estate Planning Considerations: Retirement Assets

People work much of their lives to accumulate assets, often in tax-favored vehicles such as IRAs, Roth IRAs, 401(k)s. It’s often desirable to stretch-out withdrawals from these assets, not just during the Owner’s life, but long after the owner’s  death. Other than your home, retirement accounts may be the bulk of the assets in your estate, handling these assets properly is essential.

First, let’s look at the income tax issues of retirement assets. Retirement assets may be tax-deferred, like a traditional IRA or 401(k). Or, they may be tax-free, like a Roth IRA or Roth 401(k). After the death of the owner, the beneficiary’s life expectancy is used to determine the withdrawal of the funds, also known as the stretch. The younger the beneficiary, the longer the stretch. An 18-year-old has a life expectancy of 65 years, whereas a 70-year-old has a life expectancy of 17 years. The beneficiary must take a Required Minimum Distribution each year. Generally, the required distribution is the account balance at the end of the prior year divided by (the beneficiary’s life expectancy at the Participant’s death less the number of years since the Participant’s death). So, the required distribution is much greater for older beneficiaries.

All things being equal, it’s better to leave retirement plan assets to a younger beneficiary. Also, consider whether the beneficiary will be able to leave the assets in the plan for the stretch period. It’s better to leave the assets to a beneficiary who can take advantage of the stretch.

Next, consider the likely future income tax bracket of the beneficiary. Let’s say Mary has two children, John and Susan, who are her beneficiaries. Susan will be in the top tax bracket when taking distributions, John will be in a very low tax bracket. Let’s also say Mary has two IRAs, one is a traditional IRA and one is a Roth IRA. If Mary leaves the traditional IRA to John, he’ll pay less tax on it than if she left it to Susan. The tax-free nature of the Roth would benefit Susan more than it would John.

Finally, consider non-tax considerations. Mary could name a trust as the beneficiary for John or a Trust for Susan.

For example, if Mary is concerned John might be a party to a future divorce, Mary might designate a trust as the beneficiary of the retirement plan for John instead of John individually. John could be the trustee of the trust and take distributions from the trust for his own benefit, but the assets could be his separate, non-marital assets and not subject to division upon divorce.

If Mary were concerned about creditor protection for one of her children, she could name a trust as the beneficiary of the IRA and have a third-party trustee manage the assets.

Tax and non-tax considerations should all be considered when planning for distribution of Retirement assets.