If you have a qualified retirement account, like a traditional IRA or 401(k), you probably already know they can provide an effective way to save while you reap the benefits of tax-deferred growth. That means you don’t have to worry about paying taxes while your money is in the account.
As the saying goes, the two things in life you can’t avoid are death and taxes. Eventually, taxes on these qualified accounts are going to be due, even if you have passed away. This is why it may be important to consider the tax implications for your beneficiaries. Estate taxes, income taxes, penalties and fees can add up to a hefty sum that can greatly diminish your death benefit.
With a little planning, you can take steps to lighten the tax load for your loved ones after you pass away. Below are a few tips that can help you minimize their tax exposure:
Meet yearly minimum distribution requirements.
Most retirement plan accounts have required minimum distributions that go into effect once you reach age 70½. This is the minimum amount you’re required to withdraw from your funds each year. That amount will vary based on your life expectancy; often, your required minimum distribution will increase as you get older.
If you fail to take your required minimum distribution, you’ll have to pay an excise tax that equals 50 percent of the distribution amount not taken as required.1 If you fail to pay this excise tax, your beneficiaries will be forced to pay it. You can ensure your loved ones avoid having to deal with this by taking your required minimum distributions and paying any excise taxes now, so they’re not left with the burden once you’re gone.
Designate a beneficiary.
One of the major advantages of qualified plans such as IRAs or 401(k)s is they enable you to name one or more beneficiaries. Upon your death, those account funds bypass probate and are paid directly to your beneficiaries. This saves your loved ones the administrative expenses and delays typically associated with probate.
If you don’t name any beneficiaries for these accounts, or if they’re no longer living, your account is paid to your estate and put through the probate process. You may want to review your beneficiary designations and make sure they’re up to date.
Discuss options with your family.
Your loved ones will surely appreciate being named as a beneficiary, but the tax bill that comes with an IRA or 401(k) distribution could be an issue for them, especially if it’s a significant sum. A large death benefit amount may even push them into a higher tax bracket.
That’s why it may be a good idea to consider the possibility of any unintended, less-than-favorable consequences that could arise, and to discuss different options with your family in advance.
Your beneficiaries may not necessarily have to take the funds all at once if they’d prefer not to do so. They may potentially opt to receive payments over a span of several years or even their lifetime. This would spread out the tax payments, as a result, and may help prevent them from becoming a burden.
You and your beneficiaries may want to meet with your financial planner to explore their options ahead of time. You can also give us a call at Gregory Financial Group and speak with one of our financial professionals today. We welcome the opportunity to help you and your loved ones develop a strategy.
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