Helpful miscellaneous articles
regarding our retirement plan and planning.
Like you, I review my retirement nestegg and plan from time to
time. Recently, I went though some continued
education for some credentials I maintain and it occurred to me that we all
could use a review about these issues.
So with your help, we will share and post articles and info that may be
helpful and of interest to many of you in this section.
Since much of our
retirement savings are in IRA’s, here is the first article on the “stretch
IRA:”
Deborah L. Jacobs,
Forbes Staff
How To Stretch Out An IRA
I was a guest on an estate planning
radio show recently when a listener from Traverse City, Mich., phoned with an
eye-opening question. “Do I have to convert a traditional IRA to a Roth to make
it a ‘stretch’ IRA?” she asked.
The short answer is: Absolutely not.
But what a wake-up call! It made me realize that, with all the talk this year
about Roth conversions, plenty of well-informed people are understandably
confused about this issue.
First, keep in mind that the term
“stretch,” does not denote a specific type of IRA, but rather a financial
strategy to stretch out the life–and hence the tax advantages–of an IRA.
http://www.forbes.com/2010/05/04/stretch-ira-roth-estate-taxes-personal-finance-13-tips_slide_2.html
Before Congress created Roth IRAs,
the term “stretch IRA” was used to describe the strategy in which a spouse,
child or grandchild inherits a traditional pretax IRA and then draws out
distributions (and hence tax deferral) over his or own life expectancy. The
longer the life expectancy, the smaller–as a percentage of the IRA balance–each
payout must be.
With a traditional IRA the money is
taxed as it is taken out of the IRA wrapper, whether by the account owner or
beneficiaries. So stretching out the IRA gives the funds extra
years–potentially decades–to compound tax-deferred–a wonderful investment
opportunity.
With the emergence of the Roth (and
beginning this year, the availability of Roth conversions to taxpayers at all
income levels), there are now more ways for IRA owners to stretch out tax
benefits for themselves and their heirs. There is also, no surprise, more confusion.
Here’s what you and family members
can do to maximize tax savings.
What IRA Owners Can Do
With a traditional IRA the owner
must start taking withdrawals by April 1 of the year after turning 70 and a
half. Calculating this required minimum distribution (RMD) is usually fairly
straightforward. You take the account balance on Dec. 31 of the previous year
and divide it by the number of years left in your life expectancy, as listed in
the Internal Revenue Service’s “Uniform Lifetime” table.
For example, if Sally, a widow, will
be 75 in 2010 and the account balance at the end of last year was $100,000, the
RMD for this year is $100,000 divided by her remaining life expectancy of 22.9
(from the IRS table), or $4,366.81. Each year she must take another withdrawal,
computed the same way. (If Sally has remarried and her husband is more than 10
years younger and the sole beneficiary of her IRA, she can use the “Joint Life
and Last Survivor Expectancy” table instead, and her RMD each year would be
smaller.)
Here’s where the Roth confusion
comes in. In a Roth conversion you move money from a traditional IRA to a Roth
IRA, paying ordinary income taxes (preferably with non-IRA funds) on whatever
amount you shift. You don’t have to take yearly minimum distributions from the
Roth, and future growth in it is tax-free, as are future withdrawals. That
means unless you need to withdraw the money to live on, there will be more left
in the IRA for your heirs to stretch out.
So by converting to a Roth, you can
leave a larger IRA to your heirs and it will be a tax-free, rather than a
tax-deferred, IRA. That’s why you’ve been hearing so much about Roth
conversions and their advantages for those affluent enough to leave money to
heirs. (Click here for “Ten Reasons To Convert To A Roth.” or http://www.forbes.com/2010/03/09/roth-ira-conversion-tax-retirement-personal-finance-10-reasons-convert_slide.html )
The other thing that influences the
value of a stretch-out for your family is your choice of beneficiary. You must
indicate this on the beneficiary designation form you fill out when you open
the account. (You can later amend this form. If you opened the account long
ago, check the form you have on file to make sure it’s what you intend.) Money
in an IRA is distributed according to this form, not your will.
Non-spousal heirs, regardless of
their age or the type of IRA, must take RMDs; a Roth conversion eliminates RMDs
for you, but not for them (more lenient rules apply to spouses). These RMDs are
based on the heir’s life expectancy, so the younger the beneficiary, the less
he or she must take out each year. Therefore, if maximizing the stretch-out is
the main goal, the best person to designate as a beneficiary is someone young.
One thing you should never do is
name your estate as the beneficiary–a mistake even smart, highly educated
people have made. If you do, under the worst combination of circumstances,
funds might have to be withdrawn within five years of your death. With a
traditional IRA all the income tax would have to be paid as the money comes out
of the IRA. This could also happen if you do not name a beneficiary at all, or
if no one can find the beneficiary designation form when the time comes.
Make sure to also name contingent
beneficiaries. If you don’t and your named beneficiary dies before you, the
money will revert to the estate.
What IRA Beneficiaries Can Do
For better or worse, IRA owners
can’t control whether inheritors take maximum advantage of the stretch-out. Any
heir except a spouse must begin taking withdrawals starting on Dec. 31 of the
year after he or she inherits the account. The required withdrawal is computed
the same way as it is for owners, but using a different IRS table known as the
“Single Life Expectancy” table.
Consider Harry, who leaves part of
his IRA, worth $100,000, to his grandson, who is 21 when Harry dies at age 69.
The grandson must begin taking RMDs the year following Harry’s death but can
stretch out withdrawals for the rest of his life. Based on an account balance
of $100,000, the grandson’s first required distribution at age 22 is $100,000
divided by his life expectancy of 61.1 years (from the IRS table), or
$1,636.66.
If he continues to withdraw just the
RMD each year, and the investments appreciate at a steady rate of 6%, this inheritance
will be worth $342,854 by the time the grandson reaches age 65–and could
provide a tidy nest egg for his own retirement, according to calculations by
Brentmark Software.
But what if the self-indulgent
grandson cashes the money out early to buy a BMW? Or what if he needs it to
help finance the purchase of a house or a child’s college education? In
financial lingo this is called “blowing the stretch-out.” And in real life it
happens all the time. The grandson will owe ordinary income taxes, or if it’s a
Roth, no taxes. But there’s no “early withdrawal” penalty as there might be if
he were taking money from his own IRA before retirement.
What Spouses Can Do
Most married people name their
spouse as beneficiary of an IRA, and the law gives a spousal inheritor special
privileges. A spouse–let’s assume it’s the wife–can roll the assets into her
own IRA. For a traditional IRA that means she can postpone RMDs until the year
after she turns 70 and a half. Or after rolling over the IRA she can convert it
to a Roth and eliminate the need to take withdrawals altogether. If she has
inherited a Roth, she can achieve the same effect by simply rolling it into her
own name.
Still, unless your spouse is much
younger than you are, the potential stretch-out is shorter than if you named a
child or grandchild as the designated beneficiary. Sometimes there’s no
alternative–for example, your spouse might need the money. If you cannot be
sure ahead of time, keep your options open: Make your spouse the primary
beneficiary and name a younger person as the contingent or alternate
beneficiary. (Again, you must do this on the beneficiary designation form.)
When you die, your spouse can decide whether to inherit the IRA directly and
roll it over into his or her own IRA, or disclaim (turn down) the inheritance.
In that case it would pass to the younger beneficiary you named, who can take a
longer stretch-out.
Note that if you haven’t named a
contingent beneficiary, your spouse won’t have this option. And in any event,
he or she can’t decide who gets the IRA in case of a disclaimer. It’s something
only you can map out in advance when you fill out the beneficiary designation
form.
http://www.forbes.com/2010/05/04/stretch-ira-roth-estate-taxes-personal-finance-13-tips_slide_2.html
Deborah L. Jacobs, a lawyer and
journalist, is the author of Estate
Planning Smarts: A Practical, User-Friendly, Action-Oriented Guide
(DJWorking Unlimited, 2009).
~~~~~~~~~~~
(As
with any of these informative articles, anyone who needs someone to talk to
about
this
very subject contact me and I can direct you to a knowledgeable advisor).
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Full post disclaimer in left column. PCN Home Page is located at: http://pcn.homestead.com/home01.html
No comments:
Post a Comment