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Ask the Expert: Leaving an IRA to a minor beneficiary, Part 3

What's the best way to leave my IRA to my 2-year-old grandson? (Part 3)

Under new rules, your grandchildren must empty their inherited retirement accounts at the end of the 10th year following the year of your death. The result: If you leave a big IRA to a small child, at age 18 he may inherit a substantial sum … and a huge tax bill.

You could leave the IRA to a discretionary trust for his benefit. But trusts are expensive — and IRA funds held in a trust are subject to trust tax rates, which far exceed those paid by individuals and married couples. (In 2020, trusts pay a 37% rate starting at $12,950 of income. Individual rates and rates for couples filing jointly only reach 37% at $518,400 and $622,050 of income, respectively.)

Alternatively, you could convert the IRA to a Roth IRA in a series of taxable annual conversions and leave the Roth to a trust for your grandson's benefit, says Ed Slott, a Rockville Centre tax accountant: "An inherited Roth IRA must also be paid to its trust beneficiary within 10 years of your death. But the payout from the Roth to the trust is tax-free."

A heads-up: Roth conversions are more attractive this year because the new stimulus act says you don't have to take 2020 RMDs. Let's say your RMD is $2,500 and you want to convert $10,000 from your traditional IRA to a Roth IRA. Normally, you'd have to take your RMD before doing the conversion. The upshot: You'd pay taxes on $12,500, but deposit only $10,000 into the Roth IRA. This year, you can convert the full amount, says Slott — paying taxes on $12,500, and depositing $12,500 into the Roth.

The bottom line

Inherited IRAs are subject to new rules.

More information

TO ASK THE EXPERT Email questions to Include your name, address and phone numbers. Questions can be answered only in this column. Advice is offered as general guidance. Check with your own consultants for your specific needs.

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