Retirement Accounts such as 401 K accounts and IRAs require special attention when planning your estate. Through careful planning you can leave a legacy to your heirs through your retirement account.

General Rules about Retirement Accounts.   You put money away your whole life in pre-tax accounts such as a Traditional IRA or 401 K.   When you turn 70 ½ years old the government makes you start taking Required Minimum Distributions (“RMDs”) each year so that they can start taxing the money being held in that account.  Here are some simplified rules on how RMDs work and their impact on your estate plan.

1.  Required Minimum Distributions:  At 70 ½ years old – you are required to take out RMD’s.  The government takes your age and the amount of money in your retirement account and calculates what your RMD is going to be each year.   If your RMD is $10,000 for that year – you have to withdraw $10,000 from your IRA and pay income tax on that $10,000.

2.  Spouse Inheriting a Retirement Account:  If you die and are married your spouse can roll your retirement account into their own retirement account and not take RMD’s on that money until they turn 70 ½ themselves.

3.  Inherited Retirement Accounts:   Anyone that inherits your Retirement Account (that is not your spouse) has what is called an “Inherited IRA”.   That means that they inherit your IRA – but they have to take RMD’s out beginning the first year they inherit the account.   For example – let’s say you have an IRA worth $1,000,000 at the time of your death and you name your 40 year old son – Tom – as the primary beneficiary of that account.  Tom has to start taking RMDs out immediately – he can’t wait until he is 70 ½ years old.  The federal government wants to tax the money in that retirement account (money that you have never paid income taxes on) sooner rather than later when it comes to “Inherited IRAs”.  Even though Tom has to take RMD’s as soon as he inherits the account – the money remaining in the IRA still accumulates interest tax deferred.

So in our $1,000,000 Inherited IRA example, Tom may have to take out a $10,000 RMD that year and pay taxes on that amount; however, the remaining $990,000 can remain in the IRA and accumulate interest on a tax deferred basis.  If the money in the Inherited IRA made 5% interest – that would equal $49,500.00 in income – which would continue to accumulate over Tom’s remaining lifetime.

4.   A Note about Inherited IRAs.  In our example – Tom inherits an IRA worth $1,000,000.   Tom is required to take RMDs immediately each year.  Tom is not limited to only taking out RMD’s from his Inherited IRA.  Tom could take the whole $1,000,000 out immediately.  The $1,000,000 would be treated as Tom’s income and he would have to pay income tax on that amount.  Tom could then do whatever he wanted with the rest of the money after taxes were paid.  Jay Zagorsky, an economist and research scientist at The Ohio State University conducted a study that revealed that one out of three Americans blow their inheritance.   As you can see from this example – a prudently managed inherited IRA can be a legacy – or if mismanaged – can be a tax time-bomb.

The Stand Alone Retirement Trust

If you want to make sure that your retirement account is a legacy to your heirs consider a “Stand Alone Retirement Trust” (“SRT”).  This is a special trust used to hold only retirement funds.  The SRT is named a beneficiary of your retirement account – your heirs are named as beneficiaries of the SRT. If set up properly an SRT will minimize Required Minimum Distributions for your heirs and insure that the assets are prudently managed for their lifetime.

To determine if a Stand Alone Retirement Trust is right for your estate plan, we look at the size of your retirement account; your family situation; and the other assets in your estate.   Evaluating these factors will help determine how we make your Retirement Account a Legacy for your family.