Fortunately, any money left in an IRA, 401(k), or pension at one’s death can easily bypass the probate process; they simply need to name a beneficiary or beneficiaries on these retirement accounts, and they will pass directly to the people named without the need for probate.
There is no way to get an IRA out of an estate except by taking the assets out of the IRA, paying income tax, and giving the money away before death. An IRA is subject to estate tax when one dies, and their beneficiaries will have to pay income tax as the assets are distributed from the IRA.
Retirement accounts are generally protected from creditors under Florida law. Florida Statute 222.21 protects IRAs, 401k plans, and other tax-qualified plans. If a judgment debtor owns any of these accounts, the creditor cannot reach money so long as it is held within the plan.
If a Florida resident has a Roth IRA, one can effectively avoid estate tax issues by naming heirs as a beneficiary under the account rather than passing it through their Last Will & Testament. This allows them to take over the account rather than inheriting it, sidestepping any potential estate taxes.
The 5-year rule applies to taking distributions from an inherited IRA. To withdraw earnings from an inherited IRA, the account must have been opened for a minimum of five years at the time of death of the original account holder.
Planning is even more crucial due to the special rules associated with retirement accounts, such as IRAs and 401(k)s. Retirement assets generally transfer directly to properly designated beneficiaries without passing through probate.
When a taxable IRA is inherited, the beneficiary who subsequently takes distributions pays income tax, just as the IRA owner would have, had he or she lived. The deceased IRA owner would not have paid the estate tax as well since he or she would still have been alive.
An inherited IRA, also known as a beneficiary IRA, is an account that is opened when an individual inherits an IRA or employer-sponsored retirement plan after the original owner dies. Additional contributions may not be made to an inherited IRA. Rules vary for spousal and non-spousal beneficiaries of inherited IRAs.
Retirement accounts like an IRA, Roth IRA, 401K, 403b, 457 and the like do not belong in a trust. Placing any of these assets in a trust would mean that one is taking them out of the individual’s name to retitle them in the name of their trust. One cannot put their individual retirement account (IRA) in a trust while they are living. Said person can, however, name a trust as the beneficiary of their IRA and dictate how the assets are to be handled after their death. This applies to all types of IRAs, including traditional, Roth, SEP, and SIMPLE IRAs. Accounts such as a 401(k), IRA, 403(b) and certain qualified annuities should not be transferred into a living trust. Doing so would require a withdrawal and likely trigger income tax. The primary disadvantage of naming a trust is that the retirement plan assets will be immediately subjected to Required Minimum Distributions (RMD), calculated based on the expected lifespan of the oldest beneficiary. However, naming a trust as a beneficiary is a clever idea if beneficiaries are minors, have a disability, or cannot be trusted with a considerable sum of money. Again, the major disadvantage of naming a trust as a beneficiary is the Required Minimum Distribution payouts.
Those individuals who take retirement planning seriously, they are likely contributing to an individual retirement account. The idea is to be able to draw from these resources when one retires, however, what if a person does not need the money?
Under these circumstances, the subject account could be part of an estate plan, and this is why IRA estate planning is relevant. The exact details will vary depending on the type of account that it is, and there are two of them that are widely used.
One of these is the traditional individual retirement account, and the other one is the Roth IRA. The major difference between these two accounts is the way that taxes are paid.
Contributions into a traditional account are pretax contributions, so withdrawals are subject to regular income taxes. The Roth variety works in the opposite manner. One puts money into the account after taxes have been paid, and as a result, distributions are not subject to taxation.
Now that the basics have been outlined, one can then look at five key facts that should be known about these accounts and what they mean for IRA estate planning.
The idea is for these accounts to be used when a person reaches senior citizen status. As a result, they are penalized if they withdraw money from their traditional individual retirement account before they are 59.5 years of age.
There are a few exceptions to this rule. An individual can take money out of the account to pay medical bills or school tuition, and they can withdraw up to $10,000 to help finance a first home purchase.
Roth account holders can extract portions of the principal at any time, but they must wait until they are 59.5 years old to access the earnings in a penalty-free manner.
Since the Internal Revenue Service wants to get some money before a person passes away, there is a minimum distribution requirement (Required Minimum Distributions) for traditional account holders. An individual must start receiving these distributions when they are 73 years old.
Distributions are never required when one has a Roth account. The purpose of the requirement is to give the IRS an opportunity to start collecting taxes, but Roth account holders have already paid them.
At the end of 2019, the SECURE Act was enacted. It changed some of the individual retirement account parameters. The required minimum distribution age for a traditional account is 73; it was 70.2 before the first SECURE Act raised it to 72.
Another change allowed a traditional account holder to continue to contribute to the account indefinitely. This was always the case with Roth accounts. However, before the SECURE Act, traditional account holders had to stop contributing when they reached the mandatory distribution age.
Another individual retirement account reform bill informally called SECURE Act 2.0 was enacted late in 2022. It increased the required minimum distribution age for traditional account holders to 73 in 2023, and it will eventually go up to 75.
Employers are now required to enroll all eligible employees into their 401(k) plans, and employees can opt-out. Another change allows employers to provide retirement account matches of student loan payments that are made by their employees.
If a deceased party (account owner) leaves either type of individual retirement account to their spouse, the said surviving spouse could either roll it over into their own account or title it as an inherited account and assume the beneficiary role.
For non-spouse beneficiaries, the inheritor would be required to take minimum distributions for both types of accounts. They would be taxable for traditional beneficiaries, and Roth IRA beneficiaries would not pay taxes on their IRA income.
Another change that came about due to the SECURE Act is not a favorable one from an estate planning perspective. Before it was enacted, an individual retirement account beneficiary could stretch the distributions out for any period to maximize the tax benefits. This was especially useful for Roth account beneficiaries. Now, all the resources must be cleared out of the account within 10 years.
Stretch IRAs allowed retirement-account beneficiaries to minimize total tax liability for the inherited funds while also maximizing deferred growth. Under optimum conditions, the result was exponentially increased wealth in the hands of the heir. Since the SECURE Act became law, estate-planning attorneys have been hard at work developing alternative strategies to approximate comparable results.
An effective but limited approach is to convert a traditional IRA into a Roth IRA while the original owner is still alive. Roth distributions are not taxable income, so, even though the inherited account will still need to be emptied within ten years, the funds will not be eroded by taxes during the ten-year period. In theory, each tax-free distribution is immediately reinvested in another tax-friendly investment to allow the wealth to continue growing.
The big disadvantage of converting to a Roth is that, when a person makes the conversion, they have to pay the income tax due for the account funds (ideally after a person is retired and the marginal tax rate is lower). Also, the money used to pay the taxes is no longer growing tax-deferred in the account.
A more complex, but potentially more rewarding, approach is to replace a future Stretch IRA in Florida with permanent life insurance. Because RMDs and whole life premiums are both based in part on life expectancy, it is often possible to buy a policy with a death benefit comparable to the IRA’s starting value and premiums that can be fully paid-for with IRA distributions. Upon retiring, the account owner begins taking RMDs and putting the IRA funds toward whole life insurance premiums. Taxes are owed for each distribution when made, and the corresponding premium payments decrease the IRA’s balance and increase the insurance policy’s cash value. If the retiree lives longer than expected, the policy’s cash value can be tapped to help fund later years of retirement.
When the policy’s death benefit is ultimately triggered, the payout goes to the beneficiary tax-free (life insurance proceeds are not taxable income). Alternatively, policy proceeds can be paid into a Florida dynasty trust set up to spread out distributions over the beneficiary’s lifetime like with a Stretch IRA (or for whatever other period one prefers). A trust can have the added benefits of protecting the wealth from squandering and shielding it from claims of a beneficiary’s creditors.
Any funds remaining in the IRA can be inherited as normal and must still be distributed within ten (10) years. However, because the balance has been reduced to pay policy premiums, the tax consequence should be mitigated. Since life insurance proceeds are tax-free, they can be invested in full into another tax-deferred investment and continue growing with no tax liability until distribution.
While the SECURE Act undoubtedly makes it more difficult to maximize long-term, tax-deferred growth in an inherited IRA, a thoughtful estate plan can at least partially compensate for the changes.
An experienced Florida estate-planning attorney can assist a Florida resident create a tax-efficient strategy that accounts for the new rules and provides the greatest benefit to one’s heirs.
The foregoing is a brief and general overview of the benefits of consulting with an Estate Planning attorney regarding the use of IRAs in a Florida Estate plan.
If you have any additional Questions regarding the foregoing or have any legal issue or concern, please contact the law firm of CASERTA & SPIRITI in Miami Lakes, Florida.