On the surface, the value of an individual retirement account is self-explanatory. You contribute into an individual retirement account so that you have a nest egg to draw from during your golden years. However, when circumstances are right, an individual retirement account can also be useful from an estate planning perspective.
Let’s look at the details.
Traditional Individual Retirement Accounts
You would contribute into a traditional individual retirement account with pretax earnings. This provides an immediate advantage, because your taxable income is being reduced by the amount of the contributions into the account.
That’s the good news, but the bad news is that the withdrawals that you take would be subject to taxation. You can begin to take penalty free withdrawals when you are 59.5 years of age.
With a traditional individual retirement account, you are required to take mandatory minimum distributions when you are 70.5 years old. This is because the taxman wants to get some money eventually.
Since you have to take mandatory distributions, and the distributions are taxed, the estate planning benefits are limited. However, a beneficiary could take only the minimum that is required by law after your passing. Though these distributions would be taxed, the beneficiary could still take advantage of tax-deferred growth.
The estate planning benefits of a Roth individual retirement account would be greater. You contribute into a Roth IRA after you pay taxes on the income, so the distributions that are made are not subject to regular income taxes. Plus, you do not have to take mandatory minimum distributions at any time, because taxes have already been paid.
If the beneficiary is someone other than your spouse, the beneficiary would be required to take mandatory minimum distributions. The amount of the distributions would be based on the life expectancy of the beneficiary, but they would not be subject to taxation.
Once again, the beneficiary could choose to take only the minimum that is required. This is called “stretching the IRA.” If the beneficiary stretches the account, the tax free growth would be maximized.
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