You worked hard all your life. You saved your money and you did everything the right away when panning for your retirement. You may have had retirements funds at your place of employment as well as your own personal IRA. You did everything you could possibly do to keep your money from the tax man. But did you plan for what will happen with your money when you pass on? Have you properly protected your retirement fund so that when you go to pass it on to your heirs, half of it doesn’t get eaten away by estate taxes? There are some steps you can follow to be assured you’ve set up your IRA correctly so that when that time comes, your children or grandchildren will receive the funds that you worked so hard all your life to save.
With the Roth IRA the money you contribute is money that has already been taxed. The funds that have already been taxed then stay in your Roth IRA and grow tax free until you can access them at the age 0f 59.5. 59.5 is the minimum age when you may begin withdrawing from your IRA without penalty. Sure, you can draw on your IRA funds before the age of retirement, but be aware if you do that there will be penalty of 10% on all funds you withdraw. All the money in your IRA will be drawing interest and growing tax free for as long as you leave it in the account. There is a maximum age for when you must start withdrawing money as well. At the age of 70.5, you must begin taking money from your IRA account or you will also be penalized. The penalty for not drawing money out of your IRA at age 70.5 is 50% of all the funds you were required to withdraw. This minimum is called the minimum requirement.
Roth IRAs are more popular with higher-income level individuals who want to see their tax benefits later, in retirement when they go to draw their money out. If you make enough money that you’re well into the highest tax bracket now, then deducting taxes from your IRA contributions now may not be of any benefit to you. But later on, in your retirement, maybe you’re just below the higher tax bracket. This is when the tax deduction will serve you best. And this is the main difference between the Roth IRA and the Traditional IRA, when you get your tax benefit. With the Roth IRA, it’s later on, when you go to draw on your money. With the Traditional IRA it’s now, when you contribute the money. Traditional IRAs may be more popular with middle-income people who would like to realize the tax benefits now and are not too worried about their taxes when they reach retirement, when their wages drop significantly.
In summary, rules for your IRA are:
- *Minimum age of withdraw without penalty is 59.5
- *Maximum age when you must begin drawing on your IRA is 70.5
- *You may contribute $5000 a year if you are under age 50
- *You may contribute $6000 a year if you are over age 50
- *10% penalty for early withdrawal
- *50% penalty on proceeds for late withdrawal
- *Money for IRA must come from earnings (a job)
Things to remember about passing on your IRA
Like with passing on any money, you are going to want to take advantage of all the tax benefits you can with your IRA. There is no reason to be giving to Uncle Sam what you could be giving your kids or grandkids. You must be sure to fill out all the right beneficiary forms. Here are some rules for you and your heirs to follow:
1. With you own IRA of course you can withdraw the money and move it to another IRA within 60 days, tax free, but the rules are different when inheriting an IRA. Be sure that when you move the money from your inherited IRA that you are clear it is done trustee to trustee. You must also retitle the IRA (unless it is from your spouse). You will need to clearly state the original owner’s name and declare that it is indeed inherited.
2. If you are the heir to an IRA, and you are not the spouse, you are going to have to start withdrawing from the fund by December 31 of that year. You can however, just like the original owner of the IRA, begin taking payments from the IRA over the course of your lifetime, thus avoiding any extra taxes for a total withdrawal.
3. The rules if your heir is your spouse are pretty much the same rules as applied before. Your spouse, if he or she decides to begin withdrawing money before the age of 59.5 will have to of course pay a 10% penalty. The IRA almost acts as if the original owner is still alive. The spouse does not have to begin withdrawing money until the original owner would have turned 70.5 years of age.
4. But if you are not the spouse, beware of two pitfalls. If the estate has already paid the estate tax, this can be deducted. Also, when moving the IRA over to yourself it will now begin calculating to your life expectancy, not that of the original owner.
The Estate Tax – Avoiding and Reducing Taxes
You can avoid taxes if you set up what is called a Living Trust. Example: With the living trust, or the A-B Trust, upon the death of Spouse A the IRA funds are then placed in the account of Spouse B. There is a $1 million exemption in a living trust. This is also known as the Survivor’s Trust, and no estate tax is paid upon the death of Spouse A.
You can also reduce taxes on an inherited IRA. There a basically two different approached for reducing taxes. The first way is called the spend now approach. This way of reducing tax burdens on an estate is to begin distributing the money as soon as you can. This will help to lower the total amount of the IRA and thus the tax burden it bears.
You can also avoid taxes on your estate by deferring the payments of said taxes for the longest time possible. There are certain tax tricks like the marital deduction that can help you to spread the tax burden out. Tax laws as they pertain to any IRA estate, or any estate, are extremely complicated and you should consult a tax attorney before taking any steps.
You can also of course give away a portion of your inherited IRA as a gift to avoid some hefty estate taxes. The gift-giving program, established in 2009, allows you to give away up to $13,000 a year, to as many recipients as you want, without incurring any extra tax liabilities. This includes your children and grandchildren., If you are expecting a big hit on your estate when you pass on, start moving it over to your heirs today and avoid some of those hefty taxes. For example: you can donate to two children up to $26,000 ($13,000 each) per year, every year, tax free. Additionally, you and your spouse together can double that donation to $52,000 per year. And the best part, there is no restriction on whom to may apply this gift. It can be your children, your grandchildren, a niece or nephew, anyone you choose. It can be a charitable organization, if you so choose.
You may also give away MORE than the allotted $13,00 a year if you are doing so for say your child’s or grandchild’s college, or even medical expenses. Just be sure that you make the payment directly to the school or doctor or hospital, and not to the beneficiary. This means you could pay your grandchild’s college tuition, even if it is as much as $30,000, or even more.
As stated, you may also give your IRA to charity. New laws enacted in 2010 allow you to donate up to $100,00 to charity tax free. Be aware that the donation must be made directly from your IRA to the charity. DO NOT move the funds to your personal account and then make the donation. They MUST come directly from your IRA. Also be sure that the charity is licensed and accredited by the IRS. Giving money to a non-approved charity will result in a higher tax burden.
The IRA Trust
Another method for avoiding hefty tax burdens is to set up an IRA trust. Such a trust will allow the inherited IRA to be drawn from long after the legal time period. This will inevitably increase the total amount of their lifetime payout.
Again, tax laws are very complex, especially when it comes to your estate. Please consult a tax attorney or an estate planner before taking any action with an inherited IRA.