IRAs ---TAXED OUT OR  STRETCHED OUT....ITS YOUR OPTION

IRAs for many individuals represent a significant  portion of their net worth.  For financial and estate planning  purposes, IRAs are a dual asset. During life, it is a source of income, and at death it can be the source of a substantial gift to heirs.  Unfortunately without proper planning, IRAs are subject  to a combination of taxes that can greatly reduce the death proceeds  received by the beneficiary.

At death, IRAs are included in the decedent's taxable  estate, and are subject to estate taxes. When distributed to a named beneficiary, the beneficiary will pay income tax on the death  proceeds.  When this distribution is a lump sum distribution,  these combined taxes can consume from 30 to 80 percent of the value  of the IRA at death.

Losing this much of an IRA to taxes is not a desired result, and can often be avoided with proper planning. To do so  requires an understanding of how IRAs are taxed at death, and the  options available to reduce taxes. One of the more popular options is to create a stretched out IRA which continues the tax deferral  benefits of the IRA for your heirs. To start the planning process to  protect your IRA from taxes, you need to ask many questions. For example:

Who Should Be the Beneficiary of your IRA?

The answer to this question can turn a modest  traditional IRA into a tax shelter for your family.

It takes planning, but by naming the right beneficiary, you can keep this money growing tax-deferred, not only during your lifetime, but also during your children's and  grandchildren's lifetimes.

Do I Have to Use My IRA for Retirement Income?

Assuming the IRA is not a Roth IRA, once you attain  age 70, the Internal Revenue Code says you must start taking minimum distributions.  You can take more, but not less.   If there is money left in your IRA at death, naming the right  beneficiary before your distributions begin can keep this money  growing tax-deferred for decades after your death. This tax deferred  growth can turn a small IRA into a very sizeable asset over the  lifetime of the designated beneficiary.

How Much Will I Have to Take Out?

The amount you will be required to withdraw each year  (your required minimum distribution) will be determined by dividing  the value of your tax-deferred accounts by the life expectancy of  you and your beneficiary. The elections you make to calculate  minimum distributions will control your ability to create a  stretched-out IRA.

Who Can I Name as My Beneficiary?

You have several options available: your spouse (if  you are married); children, grandchildren, or other individuals; a trust; a charity; or some combinations of the above.

Option 1: Spouse

Most married couples name their spouses as beneficiary.  In most cases, this will be your best option,  because (1) the money will be available to provide for your  surviving spouse, and (2) it gives your spouse the spousal rollover  option.

The spousal rollover technique allows your spouse to treat your IRA as his or her own IRA (assuming he or she survives you) and name a new beneficiary - preferably a much younger one,  such as your children or grandchildren. The benefit is that upon the death of your surviving spouse, the IRA can continue to be distributed over a term that can include the life expectancy of the  new beneficiary, creating the so-called stretched-out IRA.  The  key benefit of a stretched-out IRA is that the tax shelter aspect of an IRA can be extended for many years into the future.

Option 2: Children, Grandchildren, Others

If your spouse will be otherwise provided for after  you die, you have reason to believe your spouse will die before you,  of if you are not married, you could name your children, grandchildren, or other individuals as beneficiaries.

This will let you stretch out your IRA without the spousal rollover. While you are living, your beneficiary will be assumed to be not more than ten years younger than you. But after  you die, his/her actual life expectancy can be used for the remaining distributions.

Option 3: Trust

A disadvantage of naming an individual as beneficiary  is that after you die, your beneficiary can do whatever he/she wants with the money-including cashing out the full balance of the account  and destroying your carefully developed plans for long-term  tax-deferred growth. The money could also be available to the beneficiary's creditors, spouses and ex-spouses.  If any of  this concerns you, consider using a trust.

Option 4: Charity

If you are planning to leave an asset to a charity, an IRA can be an excellent choice. That's because the charity will pay  no income taxes when it receives the money.  Also, the IRA will  not be included in your taxable estate when you die, reducing your  estate taxes.

Option 5: Combining your Options

You do not have to choose just one of these options. You can mix and match your options to achieve the desired  results.  However, there are trade-offs.  Each choice has its limitations, but overall, your objectives can generally be achieved by understanding the options available to you.

Conclusion

IRAs are unique assets that offer you the opportunity  to make the IRS a big beneficiary of your IRA or not such a chosen beneficiary. From the IRS' point of view, a lump sum distribution at  the time of your death is the way to go. As this gives the IRS the opportunity to assess at least two taxes against the IRA - estate  and income.  On the other hand, a stretched-out IRA can reduce the tax liability at the time of death and continue the tax deferred growth of the IRA for many years after your death, which will make the IRS less happy, but your heirs happier. The choice is yours.