Ensuring Income Tax Deferral for Retirement Plan Beneficiaries
Some of the most generous provisions of the tax code are those that permit beneficiaries of IRAs and other qualified retirement plans to defer income tax on the plans until time of withdrawal. This allows the IRA or qualified plan to grow significantly more than if it were subject to tax on gains each year.
Another equally generous provision of the tax code permits beneficiaries to withdraw only a minimum amount from IRAs or qualified plans each year. By taking only these “required minimum distributions” a beneficiary can stretch out distributions over the better part of his or her lifetime, resulting in further deferral of income tax on the amount remaining in the plan.
Unfortunately, most beneficiaries fail to take advantage of this latter provision and withdraw all of the IRA or qualified plan funds immediately, thereby losing the significant tax advantages of tax-deferred growth.
A recent Senate proposal would have required that beneficiaries withdraw the entire IRA or qualified plan within five years of the plan participant’s death. Fortunately the Senate proposal died upon arrival, but this is an excellent reminder that retirement plans are assets that need proper planning.
A common misperception is that one should not name a trust as beneficiary because it’s overly complicated and doesn’t permit a stretch out. While naming a trust does add a thin layer of complexity, a properly drafted trust not only permits the stretch out but it is the only approach that ensures maximum income tax deferral, if that is your objective.
Unfortunately there is no “one size fits all” answer here. Rather, this is likely decided after consultation with professionals who understand these issues.