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Time for an IRA Review

July 9, 2020

The IRA was born in 1974, in the Employee Retirement Income Security Act (ERISA). Employers already received tax deductions for setting aside money for the retirement of their employees. The idea was to extend that privilege to workers themselves, if they weren’t covered already by an employer plan. IRA eligibility was expanded to all Americans with earned income in 1981, but the IRA deduction was later taken away from higher-income taxpayers. In 1997 the Roth IRA variation was introduced. There’s no upfront tax deduction, but if conditions are met, all of the distributions from the Roth IRA are tax free. Finally, a number of simpler employer retirement plans have been built upon the IRA foundation.

Tax diversification

The tax deduction for the traditional IRA contribution is welcome. It makes funding the IRA easier, especially when times are tight. But eventually the music has to be faced, and taxes must be paid.

The alternative is to have some money in Roth IRAs, with the possibility of tax-free payouts. This can create greater flexibility and control of the tax effects of a retirement income stream. Also, Roth IRAs are exempt from required minimum distributions during the owner’s life.

Multiple minor accounts

Have you set up several IRAs over the years at different financial institutions? Are you swamped by statements for the many accounts?

Consolidation of your IRAs in a single account will simplify your financial life. You’ll have just one statement to contend with, and one account to review for investment decisions. Maintenance fees may be reduced as well.

The consolidation process need not be complicated. We’ll be happy to help if you wish to take this step.

Investment incoherence

Your IRA investments should be reviewed in the context of all your investments, including 401(k) accounts and taxable savings. You want to have one asset allocation plan for all of your holdings, not a separate plan for every account. Having multiple accounts does not provide you with investment diversification if all the accounts are invested in the same way.

If you are unsure of the best investments for your IRA, seek professional guidance. Doing nothing, taking the IRA investments for granted, is not a good solution.

Check your beneficiary designations

Have circumstances changed since you specified a surviving beneficiary for your IRAs? Has there been a death, a birth, a marriage, or a divorce? You might be surprised at how often IRA designations are overlooked during a divorce.

A substantial increase in wealth also may be an occasion for changing an IRA designation. For example, if a surviving spouse no longer will need the IRA for retirement security, it may make sense to tap the IRA for charitable bequests. Such a move may save on estate taxes, inheritance taxes, and income taxes after death.

The IRA designation needs to be reviewed in the context of the overall estate plan. IRAs may be subjected to estate and inheritance taxes, and distributions from inherited IRAs (but not inherited Roth IRAs) may be subject to income taxes as well. All these taxes can eat up this asset pretty quickly, so thoughtful planning is a must.

One strategy that was popular in the past was the “stretch IRA,” in which an IRA beneficiary could take required minimum distributions from the account, geared to his or her lifetime. That option was largely eliminated by the SECURE Act, enacted as part of the budget deal in December 2019. In general, an inherited IRA must be distributed to beneficiaries within ten years of the owner’s death. Exceptions are allowed only for:

• surviving spouses;

• minor children of the owner (their ten-year period is deferred until they reach majority);

• beneficiaries who are less than ten years younger than the account owner;

• disabled beneficiaries; and

• chronically ill beneficiaries.

If you believe that one of the exceptions may be available in your estate plan, see your legal advisors promptly for optimal tax planning.

(February 2020)