IRA Accounts and Possible Stretch Reduction

In 1974, Congress created IRAs to help people save for retirement without having to pay immediate taxes on their contributions and investment gains. This is known as a traditional IRA. You can get a tax deduction for the money you put into your IRA, but only until you turn 70 and a half. You can only put cash into your IRA, unless you’re transferring property from one IRA to another. The U.S. House of Representatives recently passed a bill to simplify the rules for taking money out of an IRA after the account holder dies, and the Senate is considering a similar bill. You have to be at least 59½ to take money out of a traditional IRA without paying a penalty. If you take money out early, you may have to pay a 10% penalty plus income tax. There are some exceptions to this rule, like if you have big medical bills or if you become disabled. Not everyone can use traditional IRAs because there are income limits and contribution limits. The main benefit of traditional IRAs is that you can save money and invest it without paying taxes on it right away. You only pay taxes when you take the money out, and hopefully you’ll be in a lower tax bracket when you retire. When you reach age 70½, you have to start taking minimum distributions from your IRA accounts. If you don’t, you could be hit with a big penalty. Before that age, you can take out as much as you want without penalty. Once you reach the required age, you have to follow the rules for minimum distributions. When you have a retirement account, you have to start taking money out of it when you turn 70 and a half. The first time you have to take money out is called the “required beginning date.” If your birthday is between January and June, you reach 70 and a half in the same year you turn 70. If your birthday is between July and December, you reach 70 and a half in the following year. You can wait until April 1 after your required beginning date to take out money, but after that, you have to take out money by the end of each year or you’ll have to pay a penalty. The amount you have to take out is calculated based on the balance of your account at the end of the previous year, divided by a number based on your age. If you have a traditional IRA, you don’t have to figure out how much money you have to take out each year when you retire. The company that manages your IRA will tell you how much you have to take out. If you have more than one traditional IRA, you can add up the amounts and take the total from one IRA or a combination of them. But if you inherit an IRA, you have to take out the money separately from that account.

Roth IRAs are different because you put in money that’s already been taxed. When you take the money out, you don’t have to pay taxes on it. You can also take out the money whenever you want, without penalties, as long as it’s only the money you put in and not any earnings. And unlike traditional IRAs, you can keep putting money into a Roth IRA even after you turn 70½. So it gives you more control over your money in retirement. A Roth IRA is different from a traditional IRA, with different rules for taking money out and contributing money in. You can put up to $6,000 or $7,000 if you are 50 or older into either kind of account. When the owner of an IRA dies, the money can be given to someone else, as long as they are a person and not an estate or trust. If the owner of the IRA dies before the age of 70 and a half, the money has to be taken out within five years. If someone inherits a traditional IRA from a non-spouse, they can transfer the money into a new IRA in the original owner’s name for the benefit of the new beneficiary. This transfer is not taxed as income. The new beneficiary can choose to take all the money at once or take out a little bit each year based on their life expectancy. Younger beneficiaries who choose the second option can see the IRA grow a lot over their lifetimes. If the owner of an IRA account dies and has named more than one person to receive the money, the person with the longest life expectancy will determine how quickly the money is paid out. If the designated beneficiary is the owner’s spouse, the spouse can choose to add the money to their own account or create a separate account for the inherited money. The spouse can also decide when to start taking the money out, and may even combine the inherited money with their own. But if a trust is named as the beneficiary, the spouse can’t combine the money with their own. When a spouse dies, the surviving spouse can choose to treat the deceased spouse’s IRA account as their own. If they make this choice, they don’t have to take a required minimum distribution (RMD) in the year of the spouse’s death, but they do have to take the deceased spouse’s RMD if it wasn’t already taken. The surviving spouse is then considered the IRA owner and has to follow the RMD rules for IRA owners when they turn 70 ½. If an IRA owner dies without naming a beneficiary, the distribution mode in effect at the owner’s death can continue, but no further deferral is allowed. The RMD for the year of death is calculated as if the owner lived the whole year, and the remaining distribution period is based on the owner’s remaining life expectancy. If the surviving spouse is the sole designated beneficiary, the distribution period is recalculated annually based on the spouse’s age. When the designated beneficiary dies, any remaining IRA balance has to continue to be distributed. Designating a trust as the beneficiary of an IRA has some drawbacks, like potential legal issues and higher taxes. There’s a proposed law called the SECURE Act that could change retirement benefit laws. The SECURE Act made changes to IRAs, like allowing people to keep contributing after age 70½ and delaying when they have to start taking money out. It also limits how long nonfamily members can take out money after the IRA owner dies. The Senate is considering another bill that could have similar effects. It’s important for financial advisors to keep an eye on these possible changes and how they might affect their clients. The given information includes legal regulations and rulings about designated beneficiaries for retirement accounts. It also includes references to specific sections of the tax code and regulations. Lorna A. McGeorge, who is a lawyer, focuses on taxation, estate planning, and trust and estate administration. This information is provided by the Tax Law Section, with Janette M. McCurley as the chair, and Taso Milonas, Charlotte A. Erdmann, and Jeanette E. Moffa as editors.

Source: https://www.floridabar.org/the-florida-bar-journal/ira-accounts-and-possible-stretch-reduction/