In our society legacies matter.
When we look at people, we want to know what will be the lasting effect of their actions. Whether we are talking about President Trump, Yankee great Derek Jeter, or the elementary school teacher who fostered a love for learning in her students over the course of 40 years, what each individual leaves behind matters.
Legacies, in a sense, carry on the life and character of an individual or a group of individuals. For example, the choices that President Trump has made thus far during his tenure in office will influence the politics of many (conservative, moderate, and liberal) for generations to come.
The choices Derek Jeter made during his storied 20-year career with the New York Yankees will prove to future generations that it is possible to do right and be successful, even when so many in your industry are doing wrong.
The choices the elementary school teacher made to create a culture of learning will act as the catalyst that will create future teachers, mechanics, engineers, police officers, doctors, and lawyers.
The question then is: what does this have to do with my retirement and legacy planning?
Without proper planning, you might be setting your heirs up to receive much less than you thought. This, after the government takes a samurai sword to what you intended to leave behind.
At this point, it would be nice if there were a way to pass along your IRA, tax-deferred (or samurai-sword-deferred, if you will). Luckily, there is.
The Stretch IRA
Just as individuals can extend their lives across multiple generations through the legacy they leave behind, the same can hold true for an IRA. One little talked about part of financial and estate planning is using a tactic known as a stretch IRA.
As the name implies, it is possible to stretch, or extend, the financial life of your IRA spanning potentially generations. And what’s better, it remains tax-deferred.
- Full Cash Distribution. This is generally a “no-no,” because the beneficiary would then supercharge their taxable income for the year. Imagine you have an IRA worth $300,000 and pass away. If your beneficiary wasn’t educated properly on their options and chose to take the funds in hand, they’d wind up adding $300,000 to their taxable income for the year. When tax time comes, ouch!
- “Stretched” Distributions. While some beneficiaries might choose to take the funds over a 5 or 10 year period to reduce the tax burden, others might choose to withdraw a required minimum balance each year over their lifetime. That means that drastically less money is required to come out each year, reducing the tax burden and allowing the miracle of tax-deferred growth to continue to happen.
Using the example above, let’s say a beneficiary chose instead to utilize “stretched” distributions, rather than taking a full cash distribution. In this case, they wouldn’t need to take any money out of the account in the year you passed.
The year after you passed, they’d likely only need to take out just under $8,500. That number would be calculated off of their younger age, not the age you were when you passed, meaning that the required distribution amount would be minimized.
Adding $8,500 to their taxable income for the year likely sounds much more appealing than adding $300,000.
What if they want to take out more?
No problem! They can take out as much as they want, so long as the minimum is satisfied. This is simply a strategy to help preserve more of the assets in the retirement account you are passing down.
Potential Changes to the Stretch IRA
It is important to mention the SECURE Act that is working slowly through Congress. There are several provisions within the act as it stands that would change the retirement and legacy planning landscape, specifically regarding a stretch IRA. Should the SECURE Act go through as-is, the “over their lifetime” option would go away. Inherited retirement accounts would be required to be liquidated over a maximum of a 10-year period.
Part of leaving a good legacy is being a good communicator. Part of being a good communicator is having good conversations. Make sure you are having those conversations with your loved ones, especially if you have retirement accounts. You just might end up saving them a bunch in taxes and, as a result, leaving them more money for years to come