For many people, the largest assets they own are their homes and their retirement funds. As such, it makes sense to pay special attention to those assets when developing an estate plan. This post will discuss options available to transfer retirement funds at death.
Different options are available for spouses (as compared to non-spouse beneficiaries) when dealing with an outright transfer. The first inquiry must be to determine who the beneficiary will be. A spouse maintains the option to roll the deceased spouse’s IRA into his or her own. This is a tax-free transfer. The IRA may also be inherited, either as a lump sum or over time. Either way, however, the spouse must begin drawing funds from the IRA immediately. Non-spouses do not enjoy the rollover option, but must also begin drawing funds from the IRA immediately.
The second question becomes: How quickly must the money be withdrawn? The default rule is that a non-individual beneficiary (charity, corporation, most trusts) must inherit the retirement benefits within five years (if the person died BEFORE April 1 following the year the owner turned 70½) or over the owner’s life expectancy (if the owner died AFTER April 1 following the year he turned 70½). This rule explains why the standard advice is to name a human as a beneficiary; in that event, the retirement benefits may be distributed over the course of the beneficiary’s life expectancy. That life expectancy is typically longer than either five years OR the owner’s life expectancy – it is referred to as “stretching” the retirement funds.
The length of time is important, as the money drawn from the IRA will be taxable to the beneficiary. A lump sum will be a much larger tax event than withdrawing a smaller amount each year. But withdrawing at a slower rate has a second benefit: it allows money to remain in the account and continue to grow. This is a win-win for many families.
However, an outright transfer – though it has favorable distribution period – has some downside as well. Much like a gift made by a will, the outright distribution provides no protection to the beneficiary. The inheritance could be attached in creditor or divorce proceedings or simply blown through from immaturity or poor financial choices. These protections are vitally important when dealing with young beneficiaries or those who may lack the skills to manage a sizable inheritance in a responsible manner.
This is where complex estate planning comes into play. Retirement benefits may be left to a very specific kind of trust, that allows the beneficiary to take advantage of the longer withdrawal period while also protecting the inheritance from creditors and poor choices. This trust must meet very specific statutory requirements, but can play an important role in a comprehensive plan. Contact Balmos Law to discuss how your retirement benefits may be “stretched,” while also providing protection to your beneficiaries.