As estate planning attorneys, we are often asked about how individual retirement accounts can be used for estate planning purposes. There has been some important recent news about the rules surrounding these accounts, and we will share it here. But first, we will provide some necessary background information.
Traditional Individual Retirement Accounts
With a traditional IRA, the deposits that are made into the account are pre-tax contributions. In the near term, this is a tax benefit, because you pay taxes on less income.
You are allowed to start to take distributions from the account without being penalized when you are 59.5 years of age. Because of the fact that you have never paid taxes on the money that is in the account, any withdrawals that you make are subject to taxation.
Since the Internal Revenue Service wants to get its cut at some point, you are not allowed to let the account grow throughout your life if you do not need the money. The guidelines mandate required minimum distributions (RMDs).
The age at which you are required to start taking required minimum distributions from a traditional individual retirement account was 70.5 before the SECURE Act was passed last year. It was raised to 72, so this will be the age going forward.
A non-spouse beneficiary of a traditional IRA is required to take distributions as well, and they are subject to taxation. Previously, a beneficiary could draw out the distributions over an open-ended period of time. Since the new law was passed, the account must be cleared out within 10 years.
The major difference between a traditional individual retirement account and a Roth IRA is the way that the taxes are structured. You pay taxes on income before you contribute it into the Roth variety. As a result, if you decide to take assets out of the account after you reach 59.5 years of age, the withdrawals are not taxed.
A Roth individual retirement account holder is never required to take distributions, for the same reason that the withdrawals are not taxed. The IRS already got their money for the resources got into the account. However, beneficiaries must take RMDs.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act was passed to provide economic relief to American citizens and businesses after the virus devastated the economy. A provision contained within the Act impacts the individual retirement account rules in a profound way.
Required minimum distribution amounts are calculated based on the value of the account at the end of the previous year. On New Year’s Day, the stock market was near an all-time high, but it plummeted when the pandemic started to take its toll.
Given this reality, it would not be fair to require people to take distributions based on the previous value of the accounts. As a response, a provision within the CARES Act has wiped away the distribution requirement for 2020.
Current traditional individual retirement account holders do not have to take required minimum distributions, and beneficiaries of both types of accounts can enjoy a mandatory distribution holiday.
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