How to Maximize Legacy Contributions

Individual Retirement Accounts make for wise investments for a wide variety of clients because of their favorable tax classification. What many don’t know is that IRAs can also be configured to provide long-term income for family members. By utilizing the advantages of a stretch or multigenerational IRA, clients can ensure they pass on extra savings to their spouse or children without forcing them to take a major tax hit.

IRA fundamentals

IRAs are common investments for long-term savings, but they do include some caveats. Namely, in most traditional IRA types, the account holder must begin making required withdrawals from the account once they reach the age of 70 ½, whether or not he or she is retired, according to the IRS. The minimum amount that must be distributed depends on the account balance at the end of the previous year. If the account is a Roth IRA, these distributions are not required until the account holder dies.

Many depend on IRAs for sustainable income in retirement. But some high net worth individuals may be able to sustain themselves with income from other investments. This is a situation when a stretch IRA may be appropriate.

Stretch IRA basics

shutterstock_125338145If someone diligently saves up to the maximum annual amount for several decades, his or her IRA balance could easily top six or seven figures. If the investor doesn’t need to rely on that income in retirement, he or she may find it more beneficial to only take required minimum distributions while alive and pass on remaining balances to children and grandchildren upon death. As children or grandchildren receive these minimum distribution amounts, the funds remaining in the IRA will continue to grow, making this plan feasible for a reliable source of long-term income that doubles as a tax-advantaged legacy account.

Download now! Stretch IRA – Wealth Transfer with Life Insurance


Common oversights

According to SmartAsset, a personal finance technology company, there are a few common mistakes people make when setting up or using stretch IRAs. These include:

  • Not taking required minimum distributions: Not everyone remembers that when inheriting an IRA, one is required to start taking required minimum distributions once they reach the age of 70 ½ years old. If this is overlooked, the new account holder could face a penalty from the IRS of 50% of the amount that was not distributed. Spouses who inherit an IRA could even face extra fines if the original account owner neglected to take the required minimum distributions before passing the account on.
  • Not stretching funds: Upon receiving the account as a beneficiary, the IRS does allow the account to be fully emptied over five years if the original owner had not yet reached the required distribution age. But this will accelerate taxation of the value of the IRA assets, and means the new owner will miss out on the potential for the funds to continue to grow. By taking advantage of the ability to stretch the fund, the beneficiary can get the most out of the fund’s value over a long period of time.
  • Not rolling over inherited funds: If you inherit an IRA from a deceased spouse, in most cases it’s advisable that you roll the funds into your own IRA. This option is only available to spouses, and can allow the funds to grow in value. When the spouse reaches the  required distribution age, however, the spouse must begin taking withdrawals from the IRA.

Incorporating Life Insurance

For individuals who do not need the after-tax required minimum distribution to sustain their standard of living, using these annual amounts to fund a permanent life insurance policy may be able to enhance the amount of wealth passed to their children and grandchildren.

The ins and outs of stretch IRAs can be tricky, but they are worth fully understanding. Talk to a financial professional about how to go about setting up a stretch IRA and how your family can get the most out of it.

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