Will I Owe Taxes on My Retirement Income?

Many retirement assets are pre-tax accounts; taxes are owed on the contents of those accounts only when there are distributions from those accounts. These types of accounts include defined benefit pensions, IRA distributions, and most payments from defined contribution plans. If the owner of those accounts passes away, then the beneficiaries will be responsible for any taxes owed on the funds. When you own one of these accounts, you must take minimum required distributions beginning at age 70 ½, which triggers your tax liability. If you pass away, however, the person who inherits the account must take out minimum required distributions whether he or she is 70 ½ or not.

One option is to name a trust as the primary or contingent beneficiary of these accounts. If the trust is set up in the proper manner, you may be able to stretch out the tax deferment period of the retirement accounts, thus creating a higher degree of asset protection. So long as the trust is valid under state law, irrevocable, clearly identifies the trust beneficiaries and their ages, and the trust documentation is provided by the plan administrator by October 31^st of the year following the participant’s death, you can stretch out the tax deferment benefits.

You also should keep in mind that social security retirement benefits are not taxed. Additionally, if you open a Roth IRA during your lifetime, you are not using pre-tax money to do so. Therefore, when you or your account’s beneficiaries withdraw funds from a Roth IRA, there are no taxes due on those funds. If the Roth IRA has been in existence for five years prior to your death, the money in the account won’t be subject to federal income taxes, either. If your beneficiary leaves the funds in the Roth IRA account, the funds will continue to grow tax-free. Since you can do a Roth conversion at any age with other accounts that were not originally set up as Roth IRA accounts, you can even add to the funds that your beneficiaries will be able to enjoy free of taxes.

While taxes are sometimes necessary, there are measures that you can take prospectively in order to protect and preserve your income and assets for generations to come. This includes taking steps to minimize any taxes due. Due to the complexities of these issues, you need an attorney who can provide you the help necessary to get through it. At Legacy Law Center, our Ann Arbor elder law attorneys can help you through any situations that may arise as you work through the estate planning process.