Stretch Your IRA

Your IRA is a valuable asset, but do you realize that Uncle Sam owns a good portion of it?  In a Traditional IRA the assets have never been taxed.  You are holding an I.O.U. to the government.  You can invest it but when you put your hand in the jar to pull out a dollar, Uncle Sam wants at least a third and maybe half depending upon how much you pull out in one tax year.

Because of the sensitive tax laws that come with a Traditional IRA it is very important that you know the rules and protect your IRA for yourself and your family.

There are rules during your lifetime, but in this report we are going to focus on the rules at death.  If you die with money in your Traditional IRA, someone still must pay the tax on that money.  There is a special provision in the tax code that requires that you designate your beneficiaries in order to preserve favorable tax treatment for them.  That simply means you must record the names of your beneficiaries on the IRA account with the custodian, the bank or brokerage firm or mutual fund company holding the IRA for you.

If your beneficiary is your spouse, she will be able to rollover your IRA into her own name and continue the tax deferral just as if it is her own IRA.  In fact, it becomes her IRA.  But, a spouse is the only one who may rollover your IRA and it becomes her own.   I have used the feminine pronoun, but the same is true of course if the husband inherits his wife’s IRA.  

The special treatment in the tax code is for a non-spouse beneficiary.  When a non-spouse beneficiary inherits an IRA, let’s say your children, they are allowed to establish what is called a Beneficiary IRA or sometimes called an Inherited IRA.  Both names mean the same.

If your beneficiary is properly designated by name with the custodian of the IRA, then he or she may set up a Beneficiary IRA and defer the taxes.  However, he must begin receiving a minimum distribution in the year following the year of the death of the owner.  If he fails to take the minimum required, the penalty is 50% of what should have been withdrawn and the taxes will be due too.  It is important to get this right.

The magic is the ability to defer most of the taxes well into the future.  The money stays invested and only a minimum amount based on the life expectancy of the beneficiary is withdrawn each year, and that withdrawal is what is taxed.  It is up to the beneficiary how much he withdraws over the minimum required, but he should know that every dollar that comes out will be taxed.

Continuing to defer the taxes beyond your lifetime can stretch your IRA for many years depending upon the age of the beneficiary.  A 42 year old beneficiary could stretch the IRA for 41 years.  A 25 year old beneficiary could stretch the IRA for 58 years.   This provides far more financial security for heirs than taking the money out of the IRA, paying taxes in the year of death of the owner and investing what is left.  

The rules are important and if mistakes are made the penalty and tax are punitive.  Seek professional help before touching an IRA which you inherit.  You are welcome to call us for a personal consultation at 540-772-4545.  We want you to protect your IRA and preserve it for generations.

Written by Connie C. Guelich, CFP, AEP, CLU, ChFC.  This represents our views at the time of this writing, and it is subject to change.  It is not intended to be personal investment advice.   If you would like to discuss your own account, please don’t hesitate to call us.  We are here to help and welcome your call.