Passing Your Retirement Savings to Future Generations

While no one can predict the strength or timing of our next economic recovery, many experts feel the U.S. may be entering a period of slower, long-term economic growth. Against this backdrop, many parents may have adult children with less earning power or fewer job opportunities than they had themselves. Parents often tell me they are looking for ways to provide their children with more financial security for the future.

Fortunately, a thoughtful estate plan can help create a bigger safety net for the next generation of your family-particularly when it comes to your IRA. If you don’t plan to use all of the money in your retirement accounts for your own living expenses once you stop working, you can gift any remaining money to your adult children and help them fund their own retirement needs. The key to turning your IRA into a source of retirement funding for your children is reducing the impact of required minimum distributions on your future account growth.

As a starting point, you may want to set up a “stretch IRA” strategy for your traditional IRA. Depending on your personal situation, you may also want to consider converting some or all of your traditional IRA to a Roth IRA. Here’s a high-level look at each of these ideas. Remember to consult with your personal wealth manager and tax professional before making any major changes to your retirement accounts. When set up properly, these strategies can help you give the gift of financial security to the next generation.

Stretching Your Retirement Savings

With a stretch IRA, you name your spouse as the primary beneficiary and one or more of your children as a secondary or contingent beneficiary. When you die, ownership of the IRA is transferred to your spouse. When your spouse dies, any remaining money is held in your spouse’s name for the benefit of your child. The advantage of this strategy is that minimum required distributions will now be based on your child’s life expectancy, dramatically reducing withdrawals from the account and allowing the account to continue growing over time.

When done properly a stretch IRA strategy can help minimize estate and income taxes and help you transfer more of your hard-earned savings to your family. However, there are some fairly large pitfalls to watch. If you forget to designate a secondary or contingent beneficiary, your IRA could pass directly to your estate and become immediately taxable, costing your heirs up to 60% of your account value. Also, if you have young beneficiaries and want to name a living trust as the contingent beneficiary, ask your attorney to make sure that your living trust is IRS qualified, which will allow your beneficiaries to employ a stretch IRA strategy.

Finally, it’s important to make sure that your children understand how a stretch IRA strategy works. A stretch IRA will provide your children with a small income stream during their working years, plus the opportunity to take much larger withdrawals in their retirement years. Your children should avoid taking an immediate, lump-sum distribution, because they’ll lose most of their inheritance to taxes. In addition, your children should leave the IRA in your spouse’s name upon inheritance, such as “The IRA of Mary Smith, deceased.” This will allow them to reset minimum required distributions based on their own life expectancy.

Converting to a Roth Account

A Roth IRA can also offer you and your family some powerful estate-planning advantages. During your lifetime, you won’t need to take required minimum distributions from your own Roth account. This means that your retirement savings can continue growing in a tax-advantaged account over time-potentially decades or even more. And tax-advantaged account growth is a powerful way to increase your retirement savings, for you and for future generations.

When done properly, your heirs will inherit a 100% tax-free Roth account. When your beneficiaries inherit the account, they will begin taking required minimum distributions from the inherited Roth IRA based on their own life expectancy. Any qualified withdrawals will be tax-free, making this a highly appealing strategy for estate-planning purposes.

Keep in mind that you’ll need to pay ordinary income taxes on any money you convert from a traditional retirement account to a Roth account. These income taxes need to be paid within two years of making the conversion. We generally recommend that you pay the taxes from a different source than the account that is being converted in order to preserve and maximize the account value.

The good news is that you have the flexibility to convert only part of your traditional IRA to a Roth if you choose, meaning that you don’t have to convert your entire account to enjoy the attractive tax advantages of a Roth. You can convert as much or as little as you choose and continue making conversions in the future. In addition, recent changes in tax law expand Roth conversion eligibility to a greater number of people, including high-income earners.

Tips for Stretching Your IRA

  • When you retire, withdraw money from your taxable accounts before taking withdrawals from your IRA. This will allow your IRA account balance to continue growing for you and your spouse. If there happens to be money leftover that you don’t spend for your own retirement, you can leave it to your children in a stretch IRA.
  • Ask your wealth manager to verify with your IRA custodian that the custodian will allow your secondary beneficiaries to stretch distributions. Some custodians may require your secondary beneficiaries to take all distributions within 5 years. If needed, consider changing custodians.
  • Make sure your kids can avoid liquidating the IRA upon the deaths of you and your spouse. Set up a qualified IRA trust for your children, which will allow them to employ a stretch IRA strategy-and keep more of their inheritance.

Your Personal Chief Financial Officer

When you work with a fiduciary wealth manager, your wealth manager serves as your personal Chief Financial Officer. He or she is able to manage your IRA within the context of your overall estate plan, making sure that you have enough income in retirement to cover your living expenses while also protecting assets for future generations. Managing your IRA properly requires an in-depth understanding of your personal goals, as well as current legal, accounting and tax guidelines. As your personal Chief Financial Officer, your wealth manager brings together several different disciplines to help you make the most of your IRA.

By David Robinson, CFP(TM)

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