Like many people, retirement savings may form a critical part of your overall financial picture. If so, it is important to ensure your retirement accounts work alongside your estate plan to protect your assets and provide for loved ones. Key components such as Individual Retirement Accounts (IRAs) and 401(k) plans come with specific rules, particularly regarding Required Minimum Distributions (RMDs). Knowing how these rules impact you and your beneficiaries can help you make better decisions. With that in mind, the Los Angeles attorneys at Schomer Estate & Wealth Advisors explain how to align your retirement planning with your estate plan in California.
Individual Retirement Accounts (IRAs)
An IRA offers tax advantages designed to encourage saving for retirement. IRAs are available in two main types, including traditional and Roth IRAs. Traditional IRAs let you contribute pre-tax dollars, often reducing your taxable income for that year. While this provides an immediate benefit, you will pay taxes on withdrawals during retirement. In contrast, Roth IRAs are funded with after-tax dollars, so qualified withdrawals later are tax-free. For individuals who expect to be in a higher tax bracket during retirement, a Roth IRA can provide valuable long-term savings benefits.
Understanding 401(k) Plans
A 401(k) is an employer-sponsored retirement plan that allows employees to invest a portion of their paycheck before taxes are taken out. Many employers match a percentage of employee contributions, which helps accounts grow more quickly. Contributions grow tax-deferred, meaning you pay taxes only when you withdraw funds. For many California workers, maximizing employer matching contributions is a key part of a strong retirement strategy.
Required Minimum Distributions (RMDs)
Although retirement accounts offer tax benefits, the government requires that money eventually be taxed. RMDs are mandatory withdrawals starting at age 73 under the SECURE Act 2.0. The IRS calculates your RMD based on your account balance and life expectancy. Failing to take an RMD results in substantial penalties. Roth IRAs do not require RMDs during the original owner’s lifetime, making them an appealing option for those wishing to minimize taxable income later in life.
RMDs and Retirement Plans
While traditional IRAs and 401(k) plans share similar RMD rules, there are a few important differences, including:
- 401(k) Plans: You must begin RMDs at 73, but if you are still working and do not own at least five percent of the company, you may delay RMDs from that employer’s plan until you retire.
- Traditional IRAs: RMDs must start at 73, no matter your employment status.
- Roth IRAs: No RMDs are required for the original owner, although beneficiaries may face distribution rules when inheriting a Roth IRA.
Inheriting an IRA or 401(k)
The SECURE Act changed how beneficiaries handle inherited retirement accounts. Before the law, beneficiaries could stretch distributions over their lifetime, but now most must withdraw the full balance within ten years. Spouses who inherit an IRA or 401(k) have options:
- Roll the account into their own IRA and follow their personal RMD schedule.
- Treat the account as an inherited IRA, using the deceased spouse’s age for RMDs.
- For inherited Roth IRAs, leave the funds to grow tax-free without taking distributions immediately.
For non-spousal beneficiaries, the 10-year rule applies. If the original account holder had not yet started RMDs, the beneficiary can distribute funds anytime over ten years. If RMDs had already begun, the beneficiary must take annual distributions for nine years and distribute the remaining balance by the end of year ten. Certain “Eligible Designated Beneficiaries” (EDBs) can stretch distributions over their life expectancy. This group includes:
- Minor children (only until reaching adulthood)
- Individuals who are disabled or chronically ill
- Beneficiaries less than ten years younger than the deceased (When minor children reach adulthood, the 10-year rule then applies).
Tax Considerations for Inherited Accounts
Traditional IRAs and 401(k) distributions are taxed as ordinary income, which can push beneficiaries into a higher tax bracket. Planning withdrawals carefully, such as spreading them over several years, can help manage tax liability. Roth IRA withdrawals remain tax-free, making them attractive for passing wealth to the next generation without a large tax burden.
Aligning Retirement Accounts with Your Estate Plan
To ensure your retirement accounts fit within your estate plan be sure to keep beneficiary designations updated to ensure assets transfer smoothly without probate. Also, consider using trusts when appropriate, particularly to control distributions for minor or financially inexperienced beneficiaries. Finally, plan withdrawal strategies carefully to reduce taxes for your beneficiaries.
Can We Help You Incorporate Your Retirement Plan into Your Estate Plan?
For more information, please join us for an upcoming FREE seminar. If you would like help incorporating your retirement plan with your California estate plan, contact the experienced Los Angeles estate planning attorneys at Schomer Estate & Wealth Advisors by calling (310) 337-7696 to schedule an appointment.
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