Your IRA from a Tax Loser to a Tax WinnerDecember 1, 2015
Sadly, most taxpayers play their IRA cards wrong. Result: Your family loses. This article provides a roadmap of what to do and what not to do with your IRA.
First, some basic rules on traditional IRAs, which allow for a deduction when you put funds in and defer income taxes on profits, income and gains until you take the funds out.
1) All other qualified plans, such as 401(k)s, can be rolled over into your IRA.
2) You must take required plan distributions (RPDs) every year, starting with the year after you reach age 701⁄2. RPDs are based on life-expectancy tables, so the percentage required to be distributed increases a bit each year.
3) If you make the beneficiary of your IRA your spouse (younger than you) the RPD—when you pass away—will be smaller than yours. Good tax planning!
What if you make your kids beneficiaries? Now the friendly life-expectancy tables make the RPD so small, almost all of the IRA funds can grow—tax deferred—for another full generation. It's called a stretch IRA. Make that two generations if you leave all (or some) of your IRA to the grandkids. More great tax planning!
What Not to Do
Do not make your IRA beneficiary your estate or trust—this prohibits you from creating a stretch IRA. Instead, pick live family members: typically your spouse, then kids and/or grandkids. Remember, the enemy is a possible double-tax on your IRA—income tax, and (if your estate is large enough) the estate tax. The average double-tax rate is 64 percent.
Why Make Your Spouse the IRA Beneficiary
Let's look at the tax goodies that follow by making your spouse the beneficiary:
1) Your spouse can roll your IRA funds into her own IRA, pushing the RPD down the road to her 701⁄2 age.
2) Your spouse can name new beneficiaries—most likely your kids and grandkids—based on current circumstances.
3) Your spouse can convert the IRA into a Roth IRA, delivering a huge tax advantage to your family's younger generations. The conversion can take place all at once or over several years. Don't forget, any income tax paid is gone and no longer subject to estate tax.