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With the increased limits for individual retirement account (IRA)
contributions and the ability to roll over 401(k) balances to an IRA
when leaving a job, many investors could have significant balances.
As a result, IRAs are becoming more than just retirement planning
vehicles. They are also estate planning tools
for investors who won't use the entire balance during their
lifetimes. IRAs have become even more attractive as estate planning
tools under the Treasury Department's distribution rules.
There are ways to help stretch your IRA balance if you want to
benefit your heirs. Suppose you have a large traditional IRA
balance, which includes a rollover from your 401(k) plan. You don't
have to start taking distributions until age 70 1/2. After that, you
must start taking minimum distributions based on your age.
When you die, you can leave the IRA to your spouse, who can roll the
balance over to his or her IRA and can name his/her own beneficiary,
perhaps your children or even grandchildren. Your spouse can delay
taking distributions until age 70 1/2.
When your spouse dies, your children inherit the IRA, which can be
divided into separate IRAs for each child. Each child can then take
distributions based on each of their life expectancies and can name
their own beneficiaries. This process can continue to repeat as long
as there are funds in the IRA. By taking only minimum distributions
when required, the balance can continue to grow on a tax-deferred
basis for years and even decades.
You can further expand this concept by converting your traditional
IRA to a Roth IRA if you meet the income requirements.
Although you will have to pay income taxes on any amounts that would
have been taxable when withdrawn (for example, contributions and
earnings in a traditional IRA and earnings in a nondeductible IRA),
you can pay the income taxes from funds outside the IRA, leaving the
account balance untouched. You then would not have to make any
withdrawals during your life.
Since your spouse can roll the balance over to his or her own Roth
IRA, he or she also would not have to take withdrawals during his or
her lifetime. When your spouse dies, your heirs would then have to
take distributions over their life expectancies, but those
distributions would be federal income tax free, provided the
distributions occurred after the five-tax-year holding period.
Of course, you shouldn't lose sight of the fact that your IRA's main
purpose is to fund your retirement. An IRA should only be used for
estate planning purposes if it isn't needed for your retirement.
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