When Janice’s husband died suddenly at age 56, she was left with overwhelming shock and grief plus mounds of paperwork. We helped her deal with the paperwork as she made decisions, such as rolling over and investing the proceeds of her husband’s retirement plan into an IRA in her own name.
But then her situation got worse: within months of her husband’s death she found she had Stage 4 breast cancer, and she died just 8 months later at age 52. That’s when we were able to help the adult children avert paying taxes unnecessarily.
Janice had named the children as beneficiaries of her IRA. The general rule is that they needed to withdraw the funds and pay tax within five years, but in this case that wasn’t the smartest thing to do.
If you leave your IRA assets to the kids, they have several choices after you die. They can withdraw the money and pay all the tax due, immediately. Or they can defer that distribution over five years. This softens the tax hit somewhat, but there’s a better option still: the stretch provision. To take advantage of that provision, we established a beneficiary IRA for each child within a year following their mother’s death, and the children then elected to receive distributions over their lifetime. This allowed the funds remaining in the IRA to grow on a tax-deferred basis.
Because these children were in their 20s, they were required to withdraw only 2% a year, based on their life expectancies, and the remaining funds could grow tax deferred. Even after distributions of $12,000 a year, assuming a rate of 7%, the IRAs will grow from $450,000 to $3 million by age 65. And the children have flexibility: they can make additional withdrawals over the years without paying a penalty.
Transferring inherited IRAs to non-spousal beneficiaries can be tricky, and knowing the exceptions to the rules can make a million dollars of difference. If the kids had taken as little as $1 in distributions before they rolled it into their own beneficiary IRAs they would not have been able to take advantage of this stretch provision.
It was tragic that these children in their twenties lost both their parents so young, but their parents left a legacy through good planning and advice.