Help Protect Your Family’s Inheritance

You might contribute to your IRA for decades to help pay for your retirement. But if you don’t need all the money, you may want to leave what’s left to your children or grandchildren. However, if you want to ensure they get the most from this inheritance, you’ll need to do some planning.

Here’s a little background: Up until a couple of years ago, when you left the proceeds of your IRA to your beneficiaries, they could choose to “stretch” required withdrawals over a long period, based on their life expectancies. These required withdrawals were generally taxable, so this “stretch IRA” allowed your beneficiaries to greatly reduce the annual taxes due, while benefiting from longer tax-deferred growth potential. And the younger the beneficiary, the longer the life expectancy and the lower the withdrawals, so this technique would have been especially valuable for your grandchildren or even great-grandchildren.

Changes in laws affecting retirement accounts have significantly limited the stretch IRA strategy. Now, most non-spouse beneficiaries must withdraw all assets from the IRA within 10 years of the IRA owner’s death. The beneficiary generally does not have to take out any money during that 10-year period, but at the end of it, the entire balance must be withdrawn—and that could result in a pretty big tax bill.

The stretch IRA strategy can still be used for surviving spouses, beneficiaries who are no more than 10 years younger than the deceased IRA owner, and beneficiaries who are chronically ill or disabled. Minor children of the original account owner are also eligible for a stretch IRA—but only until they reach the age of majority, at which time the 10-year rule applies.

So, if you want to leave your IRA to family members who don’t meet any of the above exceptions, what can you do?

One possibility is a Roth IRA conversion. You could convert a traditional IRA to a Roth IRA over your lifetime, so your heirs would receive the Roth IRA. They would still be required to withdraw the assets within 10 years, but unlike with a traditional IRA, Roth IRA withdrawals are generally tax-free. These conversions are taxable, so you’ll want to consult your tax professional in addition to your financial advisor, to determine if this strategy can help you achieve your legacy goals.

Another option is to purchase life insurance, which can provide a specific dollar amount to your heirs or be used to help cover additional taxes. This may be especially advantageous if you are 72 or older, in good health, and taking withdrawals—technically these are called required minimum distributions—from your retirement accounts, such as your traditional IRA and your 401(k). If you don’t really need the money, you can use these withdrawals to pay for some or all of the insurance premiums. Life insurance can’t replace an IRA as a means to save for retirement, though, so you should consult with your financial advisor to make sure you are working toward all your goals.

In any case, if you have a sizable IRA or you don’t need the funds that you’re required to take from your retirement accounts, you may want to start thinking about what you want to do with the money. The more thorough your legacy planning, the better your chances of meeting your legacy goals.