IRAs, 401(k)s, and 403(b)s are all excellent tools for preparing an enjoyable, financially worry-free retirement. However, without taking into consideration the effect of income taxes on your retirement plans, achieving the lifestyle you desire can be filled with unwelcome surprises.
Individual Retirement Accounts – IRAs
A tax deferred IRA is a valuable retirement planning tool. You are eligible to establish an IRA account, even if you are participating in a company retirement plan. Earnings accumulated in the account will not be taxed until you withdraw them – usually at a later time when your tax rate is lower. It should be noted that Roth IRAs do not have the income tax implications during life or at death.
Lump Sum Distribution vs. Direct Deposit to an IRA
If lump sum distribution from a qualified plan is an option for you, be aware of the tax withholding requirement. When requesting a lump sum distribution, 20% will be withheld for taxes. You will have 60 days from the date of distribution to make a tax-free rollover into an IRA account. The 20% withholding tax will be refunded, but this method allows the government to have interest-free use of your money. You may wish to consider the following:
Direct Deposit of Qualified Plan to IRA
To avoid the 20% withholding tax, you may have distributions placed directly into a qualified IRA account. It is suggested that you establish a separate IRA for this purpose rather than combining your distribution with money you already have in an IRA.
Taxation of IRA Distributions
Most often, IRA withdrawals are taxed as ordinary income. If you are less than 59½ years old, there will be a 10% penalty tax in addition to the regular tax. After you reach age 70½ , distributions are required based upon your life expectancy. If you are married, it can be based on the life expectancy of you and your spouse. Your IRA withdrawals will continue to be taxed as ordinary income.
The IRD Tax Problem
Many people do not realize that at the death of the owner of an IRA and/or the surviving spouse, funds remaining in the account become taxable income to the heirs of the estate.
Income In Respect of a Decedent (IRD) What does it mean?
The term Income in Respect of a Decedent refers to ordinary income items which are included in a deceased person’s estate, but have not been included on his/her final income tax return. IRD items usually pass to the estate unexpectedly, with the unforeseen tax liabilities seldom being included in the estate planning process. Common examples of IRDs are IRAs and qualified pension plan distributions, deferred gain on commercial annuities, and interest accrued on U.S. Savings Bonds (Series EE & HH).
A donor may designate The Baptist Home as beneficiary of an IRD asset at the donor’s death. Because of The Baptist Home’s tax-exempt status, the income tax on this asset will be avoided. IRD assets can also be left to a charitable remainder trust. It should be noted that to avoid the income tax the asset must pass to charity at the death of the donor. A lifetime transfer may result in the income being taxed to the donor at the time of the gift to charity.
There are solutions to the IRD tax problem that reduce taxes and provide benefits to heirs. In order for the tax on IRD to be avoided, the charitable gift must be properly structured. We recommend consulting a professional advisor to be certain your gift is handled properly.
This article has been written to assist you in achieving your long-term retirement goals and avoiding unnecessary tax liabilities through charitable giving. Naming The Baptist Home as the beneficiary of an IRA or other IRD asset can result in tax savings for your heirs, and the funding needed to sustain our mission for many years to come. It is also a simple way to make a charitable gift at your death.
If you have questions about the tax consequences of your IRA or other assets The Baptist Home Planned Giving would like to assist please contact The Baptist Home.