How Your Kids Can Avoid Losing
40+% of Your IRA

Good Morning Relaxing Retirement Member,

Last week, we talked about the awful tax consequences your kids may face if they don’t properly handle your IRA when you’re no longer here.

To refresh your memory, if they don’t take the correct steps, they could end up handing over 40+% of your IRA to the IRS and the state of Massachusetts (or any state with income taxes) in one fell swoop!

Not an outcome that you want!

In this issue of The Retirement Coach Strategy of the Week, we’re going to walk you through the steps your kids must take to avoid this calamity!

To revisit my case study from last week, we were talking about Charlie and Doris who have been married for 38 years. They have 3 children who are all out of college and in the workforce.

After Charlie retired, he rolled over his 401(k) and pension plan to an IRA where he named his wife Doris as his primary beneficiary and his 3 children as secondary (or contingent) beneficiaries in equal shares.

Two years into retirement, Charlie suffered a heart attack and passed away.

When Charlie passed away, as Charlie’s spouse and beneficiary, Doris may transfer the money that was in Charlie’s IRA into her IRA without paying any taxes. (Key point: ONLY spouses can do this.)

Now, let’s fast forward ahead 3 more years. Doris gets sick, and after a long battle, she passes away. (Again, sorry for the bluntness of the story, but it’s necessary to properly make the point.)

At this point, Doris’ children have some decisions to make as the beneficiaries of their deceased mother’s IRA.

If they choose the path of least resistance without giving it much thought and simply withdraw the entire balance in Doris’ IRA, the entire balance is taxable at ordinary income tax rates.

Depending on their own personal tax brackets, it’s likely that they gave up 45% of their share in federal and state income taxes in one fell swoop!

In simple terms, that’s almost half of your hard earned money in one shot!

Option #2

Their second option is to establish an “Inherited IRA” upon your death which would allow the money in your IRA to continue to grow tax deferred for the rest of their lives.

The potential tax savings from this option is enormous. Imagine your money continuing to grow without taxes for decades vs. withdrawing and paying ordinary income tax rates on the entire balance up front, and then reinvesting what’s left over.

However, in order to qualify, there are two steps your children (beneficiaries) must take by December 31st of the year AFTER you pass away:

  1. They must re-title your IRA as an Inherited IRA with themselves as beneficiary. (This has to be done with an IRA custodian who can/will do it. Not all of them will do it.)

  2. They must take a small required minimum distribution from the Inherited IRA each year (similar to your Required Minimum Distribution you must take at your age 70 ½.) However, it’s based on their life expectancy, not yours, so the amount they must withdraw and pay taxes on is much less.

** The key is to make sure they are aware of this option as you can’t do it for them before you pass away. Unfortunately, most people are not aware of this.

After they examine all of their options, some may choose to receive your IRA in a lump sum (or partial lump sum) and pay the taxes up front. That’s fine as long as they’re making an educated decision.

However, once they realize the short and long term advantages, it’s highly likely that they’ll choose the Inherited IRA option so they can avoid giving up almost half your life savings!

Committed to Your Relaxing Retirement,

Jack Phelps

The Retirement Coach
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(The content of this letter does not constitute a tax opinion. Always consult with a competent tax professional service provider for advice on tax matters specific to your situation.)