One of the biggest mistakes you can make when creating an estate plan is to work on parts of your plan separately instead of viewing your plan as one big comprehensive plan. For example, you might look at retirement planning as something separate and distinct from your estate plan when, in fact, your retirement plan is part of your estate plan. A well drafted estate plan should not only provide a road map for distributing your assets after your death, but should also protect you and your assets while you are alive by ensuring that you are financially prepared for your retirement years. Another reason to combine retirement planning with your estate plan is to ensure that you understand how your retirement assets will be handled in your estate plan. For instance, do you have an IRA? If so, do you fully understand what an IRA is and how it would be handled if you were to die tomorrow?
What Is an IRA?
An Individual Retirement Account, or IRA, is essentially a special type of savings account that is designed to help you save for retirement and offers a number of potential tax advantages. IRAs are often used by people who are self-employed and who do not have an employer sponsored retirement plan; however, anyone who meets the eligibility requirements may open an IRA.
What Is the Difference between a Traditional IRA and a Roth IRA?
The primary difference between a Traditional IRA and Roth IRA is how and when they are taxed. With a Traditional IRA you pay the taxes on the back-end whereas with a Roth IRA you pay the taxes on the front-end. If you have a Roth IRA, you get no deduction for contributions, but if you follow all the rules your investment earnings will be distributed tax- and penalty-free in retirement. Traditional IRAs can provide a deduction for contributions and delay taxes on investment earnings until funds are withdrawn, typically in retirement. In addition, a Traditional IRA requires you to start taking distributions when you reach age 70 ½ whereas with a Roth IRA you can leave the funds in the account as long as you wish without worrying about any required distributions. Another important difference are the eligibility rules for opening and contributing to an IRA. Almost anyone can open a traditional IRA; however, to open a Roth IRA you must have adjusted gross income below a limit set by the IRS. For 2016, your modified adjusted gross income must be $184,000 or less if you are married filing jointly; $117,000 or less if you are single, head of household, or married filing separately.
What Are SEP and SIMPLE IRAs?
Two less known IRA options are the SEP IRA and SIMPLE IRA. A Simplified Employee Pension, or SEP IRA. is a type of traditional IRA for self-employed individuals or small business owners. Any business owner with one or more employees, or anyone with freelance income, can open a SEP IRA. Contributions, which are tax-deductible for the business or individual, go into a traditional IRA held in the employee’s name. Employees of the business cannot contribute – the employer does. Like a traditional IRA, the money in a SEP IRA is not taxable until withdrawal. On advantage to using a SEP IRA is the increased contribution levels. With a SEP, a business can contribute the lesser of 25 percent of income or $53,000 for 2016.
A Savings Incentive Match Plan for Employees, or SIMPLE IRA, is a type of traditional IRA for small businesses and self-employed individuals. As with most traditional IRAs, your contributions are tax deductible, and your investments grow tax deferred until you are ready to make withdrawals in retirement. SIMPLE IRAs allow employees to make contributions. A SIMPLE IRA is unique in that the employer is required to make a contribution on the employee’s behalf – either a dollar-for-dollar match of up to three percent of salary or a flat two percent of pay – regardless of whether the employee contributes to the account.
How Is an IRA Treated during the Probate of an Estate?
When you open an IRA you have the ability to name a beneficiary. This makes the IRA a non-probate asset, meaning it is not included in the probate of your estate if you have named a beneficiary. Therefore, if the account is still active when you die, the account assets will be paid out to the named beneficiary without having to wait for the probate process to come to an end.
If you have additional questions or concerns about how retirement planning and estate planning work together, contact the experienced Illinois estate planning attorneys at Nash, Nash, Bean & Ford, LLP by calling 309-944-2188 to schedule your appointment today.