Stretching The Growth Of An IRA

A few weeks ago, we discussed the importance and simplicity of passing wealth down to our loved ones through the use of IRA beneficiary designations. I want to focus more on this topic and discuss the optimal use of this simple tool to pass assets down to multiple generations.

The goal is simply to maximize the tax-deferred growth provided by an IRA or in the case of a Roth IRA, tax-free growth. Imagine being able to provide a stream of lifetime distributions to your children or grandchildren tax free!

In my case, I have been converting assets from a Traditional IRA into a Roth IRA over time (starting in 2010 everyone will be able to do this). My spouse is my primary beneficiary (100%) and then the assets are divided equally among our children as contingent beneficiaries. I recommend a trust if minors are involved. The game plan, if my wife cooperates, is for us to determine how much she will need/want during her life expectancy. When I kick the bucket, she will have the option to disregard our previous planning and keep all the assets for herself or heed my wise advice to disclaim any of the assets she does not need/want so they pass to the children. These assets would then be distributed based upon their life expectancies and stretch out the “income stream” over their lives tax free.

In a different scenario, there may be children from a second marriage. If the IRA owner is currently married, what they can do is specify the primary beneficiaries to receive specific portions or shares of the IRA, (i.e. Spouse 50%, Child (1) 25%, and Child (2) 25%), essentially allowing the IRA owner to steer assets to whom he or she desires. Assuming the beneficiaries are different ages, each will have a different distribution schedule based on their life expectancy.

In the case of estate tax exposure, the spouse could disclaim all or part of the IRA to a Credit Shelter Trust to fully utilize their estate tax exemption to avoid double taxation (once at distribution and second at death). Whatever the spouse does not take or control will not be included in the IRA owner’s estate and can be passed down directly to children and/or grandchildren. The only other reason to utilize a Trust as a beneficiary, except for the purpose stated above, pertains to cases involving minors or spendthrifts. Otherwise, you are better off designating individuals as beneficiaries in order to take advantage of the varying life expectancies.

Why not give the primary beneficiary options rather than force them into a situation that may be tax disadvantageous? The best thing to do initially when the IRA owner passes away is to do nothing! Take your time. The inheritor has nine months to determine if disclaiming any of the assets makes sense. Keep in mind, if any portion of the assets are taken during this period, the option to disclaim is voided.

Posted in Categories: Contributor, External Research, Personal Finance.

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