In Massachusetts, just like in many other states, the tax implications of inheriting an IRA can be significant. Without proper planning, your beneficiaries may face a hefty tax bill when they inherit your IRA. This could erode a large portion of your hard-earned savings. To address this challenge, multi-generational IRA planning offers an effective solution.
How multi-generational IRA planning works
Multi-generational IRA planning means arranging your IRA so that your children and even grandchildren can inherit it with fewer taxes. This way, you can pass on your IRA’s financial benefits to your family over a long time.
You can do this by designating your beneficiaries as “Inherited IRA” beneficiaries. This allows them to take smaller, yearly distributions based on their life expectancy. It reduces immediate taxes and ensures the IRA helps your family for many years.
Stretching distributions
The structure of inherited IRAs allows your beneficiaries to “stretch” the distributions over their own lifetimes. This means they can take out smaller, minimum required distributions (MRDs) each year instead of cashing out the entire IRA at once.
By stretching distributions over a longer period, your beneficiaries can significantly reduce the immediate tax burden. They only pay income tax on the distributed amount each year. They can keep more of the funds growing tax-deferred within the Inherited IRA.
The ability to stretch out distributions also provides the potential for creating long-term revenue streams for your loved ones. However, it is still wise to work with professionals well-versed in estate planning and taxation to execute this plan effectively.
A cautionary example
For example, imagine a scenario where your child inherits your IRA without the “Inherited IRA” designation. In this case, they might have to withdraw the whole IRA within five years. Now, suppose your IRA is worth $1 million; the entire sum would be added to their taxable income. This could elevate them to a higher tax bracket, increasing their tax liability.
To avoid these issues and keep your family’s tax burden low, it would be wise to seek guidance from a lawyer well-versed in estate planning and taxation, especially from those who understand the specific tax laws in Massachusetts.
