A client in the Houma area recently asked me how tax-deferred IRA’s are taxed when they go to a beneficiary. The answer all depends on the structure of your Louisiana Estate Plan and the wishes of your beneficiary, but it is possible to spread the tax out over the lifespan of your beneficiary.
Let’s say you have a $500,000 IRA and you name your 2 sons as equal beneficiaries. When you pass away, one son, who is 50 years old, decides to roll his $250,000 portion into an IRA in his name. This child will need to start taking minimum distributions from the inherited IRA every year based on his own life expectancy. Assuming he has a life expectancy of 25 years, this will equate to about $10,000 per year that must be taken out of the IRA to satisfy this required minimum distribution. The amount is recalculated each year to account for changes in value and life expectancy, but the distribution should be fairly similar for each year. That $10,000 the son must withdraw from the IRA will be added to the son’s income for the year. Because this is not a large amount of additional income, chances are this son will not pay a higher rate of income tax on these funds because the effect on his total income will not be enough to place him into a higher tax bracket.
The other son decides he wants to take his portion as a lump sum. When this occurs, the son is receiving $250,000 of additional income in the year where he takes the lump sum. This will almost certainly put the son into the highest income tax bracket, and will mean that the son must pay a higher rate of income tax to the federal government. This option is clearly not ideal. So is there anything you can do to prevent this?
To prevent the lump sum payment option and limit the amounts withdrawn from an IRA each year to the minimum distribution, you can set up a special IRA Trust for your heirs. In this trust, you will say the maximum amount that can be drawn from the IRA each year will be equal to the minimum distribution amount. This way you will save thousands in income taxes for your heirs.
If you are interested in learning about creative ways to structure the inheritance of your Retirement Accounts, call (504) 274-1980 in the Metairie and New Orleans Area or call (985) 246-3020 in Mandeville, Covington, Slidell, Houma, Thibodaux, and surrounding areas.