Plan to Make the Most of your Pension and Annuity Purchases

Written by Hersh Stern Updated Saturday, December 7, 2024

Familiarity with the best way to handle qualified tax-deferred retirement plan contributions, combined with understanding how to manage those accounts to your fullest benefit, will provide significant financial advantage. However, you also need to know how to ensure that your IRAs, 401(k)s, and other pre-tax accounts will grow tax-deferred for as long as possible, leaving a legacy that will pay your heirs for decades.

We'll show you how to maximize your retirement account. We'll be using IRAs as an example, but the rules generally apply to other qualified retirement plans as well.

Let's look at what happens if you don't plan . When age 70½ rolls around, you must begin taking mandatory minimum withdrawals from the IRA. If you haven't named a beneficiary, the withdrawals are scheduled to last for your life expectancy, and your ability to maximize deferral is reduced significantly.

At death, the IRA is part of your estate and subject to estate taxes. In addition, your heirs pay taxes on the account as money is distributed to them. If you named your estate as the beneficiary or did not name one, the heirs will be required to take money out of the IRA on the fastest schedule possible. That accelerates the income taxes your heirs pay and limits their opportunity to use the tax deferral.

The IRS requires you to make decisions on beneficiaries and withdrawal schedules by age 70½, but these should be settled long before that. And you may need the money before age 70½, so you'll have to set up a distribution schedule.

Here are 12 important rules to keep in mind to further extend the tax deferral of your retirement accounts.

1. Never name your estate as beneficiary of your IRA.
2. Never fail to name a beneficiary.
3. Never name a revocable trust as beneficiary of your IRA. This requires the account to be paid out almost immediately after death, completely eliminating tax deferral for your spouse and heirs.
4. Always name contingent beneficiaries. Plan for the possibility that your original beneficiary might die before you do.
5. Make sure your beneficiaries know not to let the financial institution change the name of the IRA account after your death. Under IRS rules, the IRA must remain in your name for a long-term tax deferral to work.
6. If you aren't married or if you know your spouse won't need the assets in the IRA, name a younger person as beneficiary. Your minimum required annual distributions will be based on the joint life expectancy of you and the younger beneficiary. The longer life expectancy means the distributions during your lifetime are lower and tax deferral is maximized.
7. When you choose the younger beneficiary, tax deferral can be extended after your death. Then the beneficiary can change the required payout schedule to closely match his or her true life expectancy. This allows the IRA to continue for decades – with income compounding tax-deferred all that time, and required annual distributions remaining fairly small.
8. Suppose you like the tax deferral you can get by naming a younger beneficiary, but don't believe the person you have in mind should have unfettered control of the IRA after your death. In this situation you can name an irrevocable trust as the beneficiary and name your heirs as beneficiaries of the trust.
9. Instead of naming multiple beneficiaries of one IRA, you might want to split the IRA into several IRAs, each with its own heir. (If the IRA has more than one heir, the life expectancy of the oldest is used in the computations.)
10. If your spouse will not be financially independent, you probably will name him or her as beneficiary. The IRA also can last for an extended period when your spouse is named as beneficiary - if you make sure that he or she knows the rules and how to handle things after you are gone.
11. During your lifetime, required distributions are computed on the joint life expectancy of you and your spouse. But after your death, your spouse can get a "fresh start" by rolling the IRA over into a new one, naming a new beneficiary, and recalculating the required distributions using the new beneficiary's life expectancy.

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The only difficulty with naming your spouse as beneficiary occurs if your spouse dies before you do, but after you reach age 70½. You can not change the beneficiary or the calculation of distributions after age 70½. But if you named a contingent beneficiary, the IRA still can last for decades.

12. Recalculate the life expectancy each year (rather than figuring out life expectancy once and then using that to compute the required minimum distributions each year). This makes the IRA last longer and reduces the distributions.

For more guidance on these issues, get free IRS Publications 590 ("Individual Retirement Arrangements") and 939 ("Pension General Rule-Non-simplified Method") by calling (800)TAX-FORM.