How Do IRAs and 401(k)s Fit into Estate Planning?

Your retirement and investment accounts are important considerations in your estate planning process. When investing for retirement, two common types of accounts are part of the planning: 401(k)s and IRAs. J.P. Morgan’s recent article entitled “What are IRAs and 401(k)s?” explains that a 401(k) is an employer-sponsored plan that lets you contribute some of your paycheck to save for retirement.

A potential benefit of a 401(k) is that your employer may match your contributions to your account up to a certain point. If this is available to you, then a good goal is to contribute at least enough to receive the maximum matching contribution your employer offers. An IRA is an account you usually open on your own. As far as these accounts are concerned, the key is knowing the various benefits and limitations of each type. Remember that you may be able to have more than one type of account.

IRAs and 401(k)s can come in two main types – traditional and Roth – with significant differences. However, both let you to delay paying taxes on any investment growth or income, while your money is in the account.

Your contributions to traditional or "pretax" 401(k)s are automatically excluded from your taxable income, while contributions to traditional IRAs may be tax-deductible. For an IRA, it means that you may be able to deduct your contributions from your income for tax purposes. This may decrease your taxes. Even if you aren't eligible for a tax-deduction, you are still allowed to make a contribution to a traditional IRA, as long as you have earned income. When you withdraw money from traditional IRAs or 401(k)s, distributions are generally taxed as ordinary income.

With Roth IRAs and Roth 401(k)s, you contribute after-tax dollars, and the withdrawals you take are tax-free, provided that they’re a return of contributions or "qualified distributions" as defined by the IRS. For Roth IRAs, your income may limit the amount you can contribute, or whether you can contribute at all.

While these types of investments will help pay for your retirement years, they may also help your family in your absence and must be taken into account in your estate planning. Revocable living trusts are a common estate planning tool, but for tax purposes it is best to first use your beneficiary designations for your investments to pass those investments along to your spouse, and then it is common to list your trust as a secondary beneficiary, so that those investments pass along to the trust in the event your spouse dies. That planning maximizes your asset protection while ensuring those investments will eventually pass along to the beneficiaries of your revocable living trust. 

If you are in the Madison, Wisconsin area and would like to talk about protecting your legacy, book a call with Coad Law to get started.

Reference: J.P. Morgan (May 12, 2021) “What are IRAs and 401(k)s?”

 

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