Mindful estate planning is about more than designating which assets you’ll leave to which beneficiaries. It also involves understanding any potential negative consequences of those inheritances and – if possible – taking steps to minimize them.
For example, if you’re like many people, you have a considerable amount of your savings in individual retirement accounts (IRAs) that you rolled over from your employer-sponsored 401(k)s. These don’t need to be included in your will, because you can designate your beneficiaries directly on the accounts. Nonetheless, doing that should be a part of your broader estate planning efforts.
What are eligible designated beneficiaries?
When you’re deciding whom you want to designate as the beneficiaries of your IRAs, you’ll probably want to consider eligible designated beneficiaries (EDBs) first. What’s an EDB and why does it matter?
Under federal law (specifically the SECURE Act), EDBs are relatives and others who are assumed to most need the continued financial support an inherited IRA can bring. They have their estimated life expectancy (based on IRS tables) to make withdrawals (known as taking distributions) from an inherited IRA without paying any penalties.
Since these distributions are taxed as income, that means they can take only as much as they need each year rather than have to withdraw a large amount that could throw them into a higher tax bracket. Those who qualify as EDBs are a decedent’s:
- Surviving spouse
- Minor children (until they become legal adults)
- Beneficiaries (related or not) who are disabled or chronically ill as well as trusts set up for them
- Beneficiaries (related or not) less than ten years younger than the decedent
If someone who’s not considered an EDB inherits IRA assets, they must take the full distribution – meaning withdraw all of the assets – within ten years.
While that might not be tax burden if someone inherits an IRA with a small balance or just a small percentage of an IRA, having to take the full distribution on an IRA valued at hundreds of thousands of dollars over a decade could have significant tax consequences for someone.
This is just one example of how not having experienced estate planning guidance can leave your loved ones and others you care about grappling with unintended tax consequences. As such, seeking personalized legal guidance is generally wise.
