Last month’s column was devoted to describing the consequences of late 2019’s SECURE (Setting Every Community Up for Retirement Enhancement) Act’s impact on the widely-used legacy-giving vehicle known as “Stretch IRAs”. Prior to January 1, 2020, a Stretch IRA came into being when an account owner named a younger, non-spouse as the beneficiary to that account upon her or his death. The new IRA owner began taking distributions according to their longer life expectancy and could maximize the earning power of the account through the inherent benefit of tax deferral which is part of any IRA. Congress acted to close what they called a “tax loophole” for “millionaires and billionaires”, but the truth was that plenty of everyday people were used to deploying the strategy as a means to pass wealth down to kids and grandkids. Suddenly, estate planning got a lot more complicated. The great news is that there are still plenty of ideas on how best to pass on your hard-earned savings to your loved ones while minimizing the hit to the taxman. We’ll discuss some of these plans below.
If you’re like a lot of savers, you have different “buckets” of wealth: real estate, taxable accounts like bank accounts and brokerage accounts, a Traditional IRA you might have rolled over from your company’s 401k or other defined contribution plan, maybe a Roth IRA. It’s important when you map out your legacy giving that you look at the whole picture and take into account how each kind of asset works and the tax consequences of each. As of this writing, taxable assets that have gone up in value (appreciated assets) like real estate and regular brokerage accounts will have a “stepped-up” value as of the date of your death for the heirs to whom they have been left. An example would be shares of stock purchased by you for $ 1,000.00 that have risen in value to $ 2,000.00. If you sell that stock on the day before you die, you’ll owe capital gains tax on that extra $ 1,000.00 your stock has gone up in value. If your heir inherits it, under current law, that person’s new cost basis is $ 2,000.00 and they can sell it right away and owe very little tax. There are limitations on real estate, so please consult a tax professional on that. Traditional IRAs contain funds that have never been taxed, so when an owner or their descendant takes a distribution, the full value of that distribution is taxable. Roth IRA distributions are tax-free to both owners and beneficiaries.
Estate planning and tax planning go hand-in-hand. When deciding which of your loved ones should get which assets, you need to think long and hard not only about your own tax situation but about that of your heirs. Maybe you’re retired and in a lower tax bracket, your spouse has pre-deceased you, and your children have advanced degrees and you expect they’ll have long, successful careers. It might make sense to begin converting chunks of your Traditional IRA every year to a Roth IRA so that most of your retirement resources will go tax-free to your kids and cut overall the gross amount of taxes paid. Perhaps your spouse has already passed and you have two children: one setting the world on fire in the corporate world with a very high income and one doing wonderful work in the non-profit world, but at a much lower salary. In this case, it would make sense to leave your Roth IRA to the first child and your Traditional IRA to your child who will be in the lower tax bracket. If you feel comfortable doing so, involve your beneficiaries in the tax-planning exercise. Because Stretch IRAs are a thing of the past, non-spouse beneficiaries of IRAs like children or grandchildren must take the entirety of the account out by the end of the 10th year at the end of the year in which the original owner died. Heirs can maximize that 10-year rule, though, and you should have a conversation with your loved ones about how they can do so. Ask your heirs to look into the future at what their tax situations might look like. Do they see a period up ahead where they anticipate big bonuses? Instruct them to only take distributions in leaner years. Does anyone yearn to go back to school, change careers or start a business? In those kinds of lower-income years, they could take outsize distributions as part of that 10-year window and minimize overall taxes. Remember, there’s all kinds of flexibility in the 10-year rule; the only part in stone is that the account must be at a zero balance at the end of 10 years.
Another smart strategy can be used if you are leaving behind both a spouse and children. The “no-brainer” is to make your spouse your primary beneficiary and your 3 kids your contingent beneficiaries. Your spouse would inherit your IRA, roll it into her or his IRA and name the children as beneficiaries. When your spouse dies, the kids each have ten years to take distributions from their new account. But what if you did things a little differently? What if you left ¼ of your IRA to each of your wife/husband and your 3 children? Your spouse would add your account to their own and, subsequently, leave 1/3 to each of the kids upon her/his death. Your kids would have a full 10 years to take distributions from the 1st parent’s inherited account and, potentially, a second full 10 years to take distributions from the 2nd parent’s account.
Interested in talking to a financial professional who can help you navigate issues like this and has even more strategies where these came from? I would be honored to hear from you! Please call me at 563-949-4705 or email me at firstname.lastname@example.org.
Securities offered through J.W. Cole Financial, Inc. (JWC) Member FINRA/SIPC. Advisory services offered through J.W. Cole Advisors, Inc. (JWCA). Huiskamp Collins Investments, LLC and JWC/JWCA are unaffiliated entities.