Will Your IRA Beneficiaries Face Fees and Taxes?

Mike Gann Estate Planning

If you’re like millions of other Americans, you’ve used an IRA to save for retirement. Since its inception in 1974, the IRA has become one of the most popular retirement savings vehicles, primarily because of its unique tax advantages.

In a traditional IRA, you may be able to deduct your contributions and your funds also grow tax-deferred as long as they are in the account. A Roth IRA works a bit differently in that it doesn’t offer deductible contributions, but does allow for tax-deferred growth and tax-free distributions. There are various other types of IRAs that have unique rules, but are generally treated like a traditional IRA from a tax standpoint.

One of the other appealing aspects of an IRA is that it has a beneficiary designation. This means that you name specific beneficiaries to receive your IRA assets after you pass away. The assets go directly to the beneficiaries and avoid the costs and delays associated with probate.

If you have a significant amount of assets in your IRA, you could leave a substantial legacy for your beneficiaries. They’ll likely appreciate the benefit and it could even help them achieve some important financial goals.

However, the IRA death distribution could also generate some unexpected costs in the form of fees and taxes. If you and your beneficiaries don’t prepare, they could be caught off-guard by some of the costs. Below are a few common expenses that IRA beneficiaries face, along with steps you can take to minimize the risk:


Excise Taxes

In most types of IRAs, you are required to begin taking distributions at age 70 ½. This isn’t true of the Roth IRA, but it is true of most others. These required minimum distributions (RMDs) are in place to begin the taxation process. After all, you may have grown your assets tax-deferred inside the IRA for decades. At some point, the IRS wants their share.

If you miss an RMD, you could face an excise tax of up to 50 percent of the distribution amount. If you pass away before paying the excise tax, it could then be levied on your estate. Your loved ones could file an appeal to have the tax waived, but there’s no guarantee the IRS will approve the request.

There’s an easy way to avoid this cost. Simply take your RMDs as scheduled. If you should somehow miss one, take the RMD and pay the excise tax as soon as possible. Your beneficiaries and heirs will thank you.


Probate Costs

Generally, IRAs don’t go through probate and aren’t vulnerable to probate expenses. However, IRA assets could end up in probate if you don’t have a living beneficiary on your account. If there is no beneficiary to receive the assets, the funds are paid to your estate, where they will likely go through probate. The probate process can be costly and time consuming, so it’s usually wise to minimize the amount of assets that go through probate.

Sometimes people forget to name beneficiaries on their IRA. Or their beneficiary could predecease them and they then forget to update their designations. Take a few minutes to regularly review your beneficiaries. Also make sure you have contingent beneficiaries listed so there will always be someone to receive the funds.


Income Taxes

Distributions from a Roth IRA usually aren’t taxable, including distributions to beneficiaries. However, distributions from other types of IRAs, including traditional IRAs, are generally taxed as income. If you pass a substantial amount of assets to your loved ones through your IRA, the distribution could push them into a higher tax bracket and generate a sizable tax bill.

Your beneficiaries have options, though. They may be able to stretch the distributions over several years or even their lifetime. In doing so, they also spread out the tax bill, perhaps making it more manageable.

Talk to your beneficiaries about their options. You may even want to bring them to a meeting with your financial professional. The more informed they are in advance, the better they can plan for their distribution in the future.

Are your beneficiaries protected? Let’s talk about it. Contact us at Advantage Retirement Services. We can help you analyze your needs and goals and develop a strategy. Let’s connect soon and start the conversation.


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