As the Baby Boomer generation ages, more estate plans need to incorporate language that accommodates qualified retirement accounts, such as individual retirement accounts and 401(k) plans. Qualified accounts are tax deferred accounts, meaning that taxes are deferred until the owner or the designated beneficiary of the account removes the money from the account.
Because the government eventually wants to receive the tax that it permits people to defer through a qualified retirement account, the rules governing these accounts require that the owner of the account and the beneficiary of the account after the owner dies remove money from the account over a specified period of time.
Every year, the owner or beneficiary must tax the required minimum distribution amount. This is the minimal amount of assets that the owner must remove every year. The amount is recalculated every year based upon the owner’s age and life expectancy tables. The younger an owner (or beneficiary) is, the longer the period of time over which the owner can remove the money from the qualified account.
An owner could remove all the money from the account in any given year; however, the owner must remove the required minimum distribution amount each year.
Sometimes, a person will come to me and tell me that he wants to establish a “stretch IRA.” A stretch IRA is a concept, not a type of retirement account.
By naming a designated beneficiary of a young age, the beneficiary can stretch out the time during which there is money left in the IRA on which the beneficiary is not paying income tax. For instance, if a beneficiary must remove money from the IRA over his life expectancy, then an eight-nine year old beneficiary is going to have to remove the money quicker (and in larger amounts) than a beneficiary who is ten years old. A ten year old is expected to live much longer than an eighty-nine year old; therefore, the law permits the ten year old to remove the money much more slowly than an eighty-nine year old.
And the longer the money remains in the IRA, the longer income taxes are deferred on the money. When a beneficiary removes money from the IRA, he must claim the amount removed as taxable income in the year in which he removes the money.
People who were born in the 1920’s and 1930’s tend to not have very much money in qualified accounts. People who were born during these decades simply didn’t work when qualified accounts existed. They tend to have defined pension plans, plans from their companies that pay them a fixed amount of money every month.
People who were born in the 1940’s and later tend to have more money in qualified accounts. So as these people age and begin to plan their estates, they will need to take into consideration their retirement accounts.
If you wish to leave a portion of your estate to a person who is a minor, how do you efficiently do this? In most instances, when you leave money to a minor, you leave it to them in a trust. A trustee is appointed to hold and administer the money for the minor until the minor attains a certain age, such as twenty-five.
With an IRA, you need to ensure that the trust qualifies as a designated beneficiary. If the trust fails to meet the requirements to be a qualified beneficiary, then the money might have to come out of the IRA much more quickly, which could cause negative income tax consequences for the minor beneficiary. The Internal Revenue Service has rules that a trust must satisfy in order to be a designated beneficiary—the trust must be irrevocable, valid under state law, the trust beneficiaries must be identifiable people, and a copy of the trust must be provided to the custodian of the IRA. A failure to meet any of these rules could result in significant income tax consequences to the beneficiary.