Investments in IRAs are the main source of funding retirement income for a vast majority of Americans. Your IRA is probably crucially important to your retirement success and may also play a role in your estate plan. Trouble is, the rules on IRAs have changed and so has the investment environment, and, as a result, taking a strategic approach is not so easy. Here is a very simplified explanation of strategic planning opportunities triggered under current estate and income tax rules.
The Rules
At age 72, the law requires you start taking money out of an IRA account annually. The required minimum distribution (RMD) is based on an actuarial table of life expectancy, which sounds complicated but don’t get hung up on it. All you need to know is that your RMDs are based on your age.
RMDs get taxed. When you withdraw the RMD annually, you will need to pay income tax on the amount withdrawn. A key aspect of IRA strategic tax planning is minimizing withdrawals on IRA accounts to keep as much of your IRA as possible growing without being subject to income tax.
How The Rules Affect You
If you die at age 72 before beginning RMDs from a regular IRA, your family will not be required to take anything out of that regular IRA for 10 years. To be clear, assuming your heirs don’t need all or any of the IRA assets you left them, they can escape any taxation of the growth on the IRA for 10 years. That’s great! The trouble is, you’re dead. This is not a strategy you want to plan on happening. You want to plan to live many years past age 72.
If you have a regular IRA and you die after the required beginning date for taking RMDs, then you will be required to take RMDs annually for 10 years to deplete the IRA. That’s not a good result because the IRA gets reduced by your required distribution annually and less principal is left to grow at a compound rate.
Roth Conversion Strategy
The key strategy for maximizing IRA assets in 2022 is converting traditional IRA assets to a Roth IRA. A Roth IRA is like dying before starting your required minimum distributions at age 72. It’s almost like you died and went to tax heaven! There are no required minimum distributions on a Roth IRA; asset growth compounds tax free all your life. It’s a great way of preserving your assets for your 80s and 90s and it offers a powerful estate tax planning benefit.
If you die, your heirs inherit a Roth IRA that must be depleted all at once in 10 years. To be clear, your heirs – assuming they do not need the assets you left for them – can let the account grow tax-free for 10 years and withdrawals by your heirs from the inherited Roth IRA is tax-free income.
Roth IRA conversion is not a strategy you want to begin to start thinking about in your 80s. If you are in your 60s and own an IRA asset that might outlive you and benefit your spouse and children after you’re gone, converting to a Roth should probably be evaluated. Conversion requires paying income tax on assets withdrawn from your regular IRA and that is a calculation you must make with a qualified professional. We are here to help always.
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