Whether it is a 401(k), 403(b), or just a regular IRA, for many people, their retirement benefits are their largest asset. That is no surprise, since retirement plans are built up over decades of contributions, which then hopefully appreciate over time.
How to dispose of these assets at death is a crucial part of any estate plan, and the tax ramifications of a careless distribution can be punishing because all retirement assets have a built-in income tax liability. The dollars in the plan are pre-tax dollars, and income tax is deferred until the participant takes money out of the account after retirement.
As an example, assume Elizabeth has a $1,000,000 IRA and a house that is worth $1,000,000 with no mortgage. She would like to leave the IRA in trust for her young children and the house to her spouse after she dies, so that everyone gets an equal share. What Elizabeth fails to realize, however, is that the IRA is really only worth $600,000, (assuming a combined federal and state tax rate of 40%), because her kids will have to pay the income taxes due.
So, how can Elizabeth get around this problem? Roth conversion or life insurance could be a solution, but perhaps it would make more sense to leave the IRA to her spouse. A spouse can take advantage of the spousal rollover and continue to defer the income taxes over his own lifetime.
If instead, Elizabeth would like both her spouse and their children to benefit from the IRA, she’ll need to consider whether to put the IRA into a trust or to split up the beneficiary designations. Both options are feasible, but each has its own income and estate tax consequences. A qualified attorney can assist you in preserving your largest asset for future generations.
Julie R. Lackner, Esq.
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