Consequences of liquidating an ira
The tax-free nature of growth on a Roth IRA makes it a highly appealing investment account to hold, and a similarly appealing type of account to inherit.All else being equal, it’s clearly better to be the beneficiary of an account that will never be taxed, than one that will be taxed over time.However, if the reality is that the beneficiary’s tax rates are actually lower – perhaps because the original IRA owner’s wealth is being spread across multiple beneficiaries, because the beneficiary simply has less income and assets, or maybe just due to the fact that the beneficiary lives in a different state that has a lower tax rate – then the best thing a (higher-income) IRA owner can do is simply to leave a traditional IRA to the beneficiary and let the beneficiary pay the taxes at his/her own lower tax rates!Michael Kitces is a Partner and the Director of Wealth Management for Pinnacle Advisory Group, a private wealth management firm located in Columbia, Maryland that oversees approximately .0 billion of client assets.There is a procedure in the tax law for making qualified disclaimers.Your heirs and executor should be aware of your intentions and this process, and you should give the executor guidelines for making the decision and advising the beneficiaries.If rates are higher in the future, it’s better to have converted now to a Roth; if rates are lower in the future, it’s better to simply keep the traditional IRA, wait, and pay the taxes in the future when the rates are lower.For those who are working, the decision about whether to contribute to a traditional or Roth IRA often becomes an evaluation of current marginal tax rates (on top of wages and any other income) versus what that marginal rate will likely be in retirement (when wages are gone, but a pension, Social Security, or other income may be present).
After your heirs and executor decide who should inherit, those who are ahead of that person in the beneficiary chain can disclaim their interests.
Instead, the heir can continue the original distribution schedule using what would have been the age and life expectancy of the deceased owner.
The IRS says that the second method is the default method if the beneficiary does not make a selection or the IRA custodian does not name the other method as the default.
In fact, ultimately the decision of whether to bequest a Roth or traditional IRA should be driven by a comparison of the original IRA owner’s marginal tax rate, and the expected marginal tax rate of the beneficiary in the future.
If the beneficiary’s tax rates are higher, it’s clearly beneficial for the current IRA owner to go ahead and convert the IRA, paying the taxes now at current rates, and leaving the (high income) beneficiary a tax-free account.
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