IRA Can Provide Family Tax-Free Income Stream

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BERLIN – You contributed to an IRA to help fund your retirement lifestyle. In fact, it’s quite possible you’ve rolled over your assets from multiple employers’ plans into a single IRA to form the foundation of your retirement savings. But what if some or all of those assets survive you? In that event, your IRA can work as a wealth-transfer tool, allowing a beneficiary to enjoy continued tax-deferred growth potential and an income stream.

Your first priority: Make sure your beneficiary information is updated. Families change, through births, marriages, divorces and deaths. At these critical times in your life, it’s easy for things like beneficiary designations to slip through the cracks.

“Some people forget to change their beneficiaries. Meanwhile, many have married or been through divorce, even remarried,” said Liz Butler, Director of IRA Product Management at Merrill Lynch. If you fail to keep information current, your intended beneficiaries may not receive your assets.

While naming beneficiaries is crucial to providing future generations with tax-deferred IRA assets that have the potential to grow, it’s just as important to share your rationale in the choice of your beneficiaries with your family and, with the help of a financial advisor, educate them in how to best handle the legacy of your IRA. By doing so, you can help prevent hasty, ill-advised decisions and unintended consequences.

If you have very clear wishes about the legacy of your IRA, you might consider a Trusteed IRA, which allows you to decide how and to whom the assets will be distributed. What’s more, these wishes remain intact after your passing.

Many ways of distributing the assets in your IRA depend on a variety of factors, including the needs of your surviving spouse or partner, your children, or other potential beneficiaries. Whatever path you take, upon your passing the beneficiary will need to choose from options with varying degrees of tax impact. Your age when you pass, your beneficiary’s relationship to you, and his or her own age will determine those available options, so you should check with your tax advisor before making any decisions.

For a spouse beneficiary, there are several available distribution options, including rolling the proceeds into his or her own IRA. With this option, the spouse treats the inherited assets as if it were his or her own. Therefore, the spouse won’t be required to begin taking distributions from the account until he or she reaches age 70½, so this can be an attractive option if there isn’t an immediate need for the assets. When distributions do begin, they will be taxable as earned income.

Another option is for the spouse to roll the assets into an Inherited IRA.

With both options, surviving spouses can continue to maximize the tax-deferred status of the assets by taking only required distributions. They can also name their own beneficiaries, perhaps designating significantly younger children or grandchildren.

These beneficiaries can employ the “stretch IRA” distribution strategy when the surviving spouse passes away if they, like the surviving spouse before them, choose to take only minimum distributions from the inherited account. Because younger beneficiaries have longer life expectancies, the annual minimum required distribution will be lower than for a beneficiary who is much older.

If your spouse needs money immediately after inheriting the account, he or she may choose to take a distribution of a portion of the inherited assets right away. He or she can then, as mentioned, roll the balance into an Inherited IRA or his or her own IRA, and then take annual distributions.

Finally, your beneficiary can choose to take an immediate total distribution of the IRA assets. This option results in immediate taxation of the entire inherited amount and should be considered only if the heirs have a clear need.

Remember that funds in your IRAs could well be your largest pool of assets. And because these assets are passed along via beneficiary designations rather than a will, your estate plan should include a focus on your IRA and the beneficiary designations to ensure that it is consistent with your overall legacy objectives. Your financial advisor can help you align your IRA beneficiary designations with your legacy goals.

(The writer is a Merrill Lynch Senior Financial Advisor. She can be reached at 410-213-9084.)

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