Strategy for Maximizing Next Generation Wealth

[kannon]

Morning.

I am starting to fine tune our financial strategy. We have been blessed with good pensions/health insurance so with that and SS, we are covered.

Our next focus is how best to help our children - i.e., best strategy for inheriting wealth.

All kids have maxed out their Roth IRAs and 401K's. Kudos to them.

My wife and I have Regular and Roth IRAs. Doing yearly conversions to Roth just under the next tax bracket. Idea is that an inherited Roth IRA is better than a inherited Regular IRA.

With estate tax, I am assuming that means that the children will inherit our regular and Roth IRAs and taxable accounts without any federal and state (Maryland) taxes as we are under the $11M threshold.

Am I correct that the inherited regular IRA RMD will be taxed at their income level while the inherited Roth IRA RMD will not be? Also - the inherited taxable account yearly interest will be taxed at their income level.

So that being said - is Roth conversions for us now make sense to maximize the next generation wealth? Thinking minimize our current RMD (from regular IRA) so maximizes what the kids inherit.

Any other strategies that we haven't thought of - max what the kids inherit and keep after taxes?

Thank you.

 

[footenote]

Non-spouse inheritors (like children) must take RMDs from inherited IRAs the year after your death:

"Generally, the IRS requires non-spouse beneficiaries to begin taking RMDs from the inherited assets beginning in the year after the year of death of the original owner. The first RMD must be taken from the newly established Inherited IRA by December 31 of that next year. So if the original owner died in 2016, then the first RMD must be taken by December 31, 2017."

Since you had not paid taxes on these funds, yes, your children will pay the taxes on required distributions (at a minimum) and that could push the RMD income into the next, higher bracket(s).

https://www.fidelity.com/building-savings/learn-about-iras/inherited-ira-rmd

If you owned a Roth IRA for more than five years before your death, you can leave that asset to a beneficiary tax-free. However, inherited Roth IRAs are still subject to Required Minimum Distributions rules with a stiff 50% penalty if they don't make the distributions.

"There are two options: The first is that the beneficiary has to take out the entire balance by December 31st of the year containing the fifth anniversary of the owner’s death. The second is more complex, but potentially much more advantageous. The beneficiary will have to start taking distributions over the beneficiary’s life expectancy, starting no later the December 31st of the year following the year of the owner’s death (this process is called the Term Certain Method)."

https://www.rothira.com/roth-ira-required-minimum-distribution-rmd

Yes, you converting your IRA(s) to Roth will be a great benefit to your (non-spouse) heirs. They will still need to understand the complexities, penalties and benefits of different withdrawal methods.

Congrats on thinking ahead. You may also want to consider a trust structure. See "How Does a Trust Affect Stretch-Out?" here: https://www.forbes.com/sites/debora...nd-trusts-what-you-need-to-know/#289e4ee0172b

 

[VanWinkle]

The "step up" basis on a taxable account will make their capital gains zero on any appreciated stocks inherited upon your demise. A taxable account with mostly stock index funds(low turnover and low taxes) can also be a valuable tool for your estate. Dividends would qualify for a lower tax percentage for the children that inherit the proceeds. If their tax brkt is higher than yours, then Roth conversions now would be a positive for future inheritance.

Maryland has their own exemption for your estate: https://www.bipc.com/new-maryland-estate-tax-exemption-for-2019-signals-trend-following-2017-tax-act

"If your estate is worth more than $4 million, though, there is a progressive tax rate for all wealth above that $4 million mark that your estate will have to pay before money can be dispersed to your heirs. In 2019, the Maryland estate tax threshold will increase to $5 million."

 

[Stormy Kromer]

You may want to place home & any real estate in a trust to avoid probate. Have a transfer on death on investment & bank accounts and make sure beneficiaries are up to date.


Have a health care directive and POA's in place and pre-plan funerals.

 

[kannon]

Beneficiaries are up to date - good advice.

Not familiar with " transfer on death on investment & bank accounts" - isn't that a standard practice to follow the list of beneficiaries after Vanguard/Ally (in our case) receive notice of death?

 

[target2019]

Examining all of your investments from the perspective of children inheriting some portion, is worthwhile. Just went through the experience, and found:
- Taxable investment accounts with equal, named beneficiaries (the children) - smooth transfer and step-up or step-down in basis. For those who inherit, immediately cash in the investments you do not want. re-invest the cash according to your asset allocation
- Inherited IRAs - may need to simplify. If parent did not take RMD, or took partial, make sure the RMD is satisfied. That is one calculation. Then calculate RMD for beneficiary, and take that in following year.
- Annuities have their own sets of rules. Hard to generalize about this.
- Home - did not have to deal with this. It would have been PIA. Fortunately parents sold the home 7 years earlier.
- Checking and savings - keep it simple. Based on what we are going through, we decided to make one child POD on checking and savings account. This child is also the executrix. Not saying all should do this, but it is best choice in our situation.

 

[SecondCor521]

In addition to the step up in basis mentioned in post #3, sales of inherited stock are treated as having a long term holding period regardless of how long they were actually held. This is a nice, but not often mentioned aspect of our tax law.

For wealth preservation, I think the generally best course of action is for your kids to take RMD's from both the inherited Roth and inherited traditional IRAs. The traditional IRA RMDs will create taxable ordinary income to them so they will pay their marginal rate on that; the Roth IRA RMDs will very likely be tax-free as noted above. Doing RMDs will stretch out the tax-deferred / tax-free compounding effect over their lifetimes.

There are some requirements you must meet for them to do these RMDs! Here is a description of the ones I know of; there may be one or two more. Also, my descriptions are approximate - be sure to research the exact details:

1. You must have them listed directly as beneficiaries on the IRAs - it cannot go through your estate. So your beneficiaries need to be "John Doe", "Jane Doe", etc., not "my will" or "my estate".

2. You can't have any beneficiaries on your IRA that are not a person. So you can't leave 20% of your IRA to a charity or a foundation or anything like that.

3. They have to have the IRA distributed to them within a certain amount of time after death of the owner.

4. The new IRA must be properly titled, including the fact that it is inherited and include the name of the original owner.

5. The RMDs must be taken without interruption - thus, the RMD for the original owner in the year of death must be satisfied, and then the RMDs for the new owners must start in the year after the year of death.

Finally, note that there is currently a proposed law in Congress - it's called the SECURE Act - which would reduce or eliminate the ability to do stretch IRAs.

...

Regarding PODs, it is possible with some banks to have multiple people listed. My Dad has a checking account and we just recently added all three of his kids as PODs so it would make the transfer easier to do (can be done outside of probate that way rather than through probate). Oddly, the bank involved didn't ask for percentages or anything; it sounds like we can distribute it any way we like.

 

[RunningBum]

An additional strategy would be to gift money to your kids while you are alive. I believe the limit now is $15K per person, so you and your wife could gift each kid up to $30K, and if they are married, $60K to the couple. I don't fully understand the ramifications of exceeding the limit if you are going to be under the $11M threshold. I know that if you are going to be over that, the additional amount reduces that threshold.

If they are in a tax bracket such that LTCGs are not taxed, you could gift them appreciated stock, which they could sell tax free.

There's really no difference between doing this now or letting them inherit it and getting a step-up in basis, so it's not necessarily a maximizing strategy.

Some may say that kids that get aid like this do not do as well as managing on their own, but another way to look at it is you are giving some of it to them to get used to more wealth before they inherit a big chunk. You can also see them enjoy it, and it can also remove any feeling of them waiting for you to die so they can get "their" money.

It's certainly a personal decision but one to consider. I have started doing this myself. I'm not going to get into the details of my situation, but I feel comfortable doing it.

 

[pb4uski]

In the situation that the OP describes, I would favor tIRA to Roth conversions only if they can be done at a current marginal tax rate that is less than the projected marginal tax rate for the beneficiaries when they have to withdraw the money.

I would favor taxable accounts because the stepped-up basis is a huge benefit and in the meantime qualified dividends and LTCG are at favorable rates.

That, and from an estate planning perspective, some states allow vehicles and/or real estate to transfer on death, avoiding probate.

 

[H2ODude]

Annnnndddd....you could always bribe their way into a top tier college!

 

[pb4uski]

Annnnndddd....you could always bribe their way into a top tier college!

That's not the way we play... in my house you have to earn your way and live with consequences of your decisions.

 

[OldShooter]

... Any other strategies that we haven't thought of - max what the kids inherit and keep after taxes? ...

Well, are you a trusts & estates specialist CPA or attorney? If your answer is "no" then the answer to your question here is probably "probably."

For example, the idea of trusts has been mentioned but as usual here it is a little fuzzy on revocable ("rev") trusts and testamentary trusts (usually created after the second death). Regarding "keep," we have testamentary trusts for our two sons. Among other things they protect our money from spendthrift behavior, con men, divorce, and legal judgments. But there is a cost -- professional trustee fees.

What if one child predeceases you? What if a child and his/her spouse die in a common disaster and someone unknown to you is named guardian of the children and gets control of the money?

IOW, estate planning is a lot more than optimizing IRA and Roth taxation. The good news is that getting a good plan will probably cost less than 1% of even a modest estate. Cheap insurance.

 

[SecondCor521]

In the situation that the OP describes, I would favor tIRA to Roth conversions only if they can be done at a current marginal tax rate that is less than the projected marginal tax rate for the beneficiaries when they have to withdraw the money.

I agree in theory. I have a question about practice.

What if there are three beneficiaries (adult children) who have different marginal tax rates? Average them, I guess?

What if the beneficiaries will have different marginal rates over time? Currently two of the three are working and drawing incomes, but when they retire they might drop a bracket or two.

Any more specific advice on these two points? Thanks.

 

[RunningBum]

I agree in theory. I have a question about practice.

What if there are three beneficiaries (adult children) who have different marginal tax rates? Average them, I guess?

What if the beneficiaries will have different marginal rates over time? Currently two of the three are working and drawing incomes, but when they retire they might drop a bracket or two.

Any more specific advice on these two points? Thanks.

It would take maintenance but maybe you try to balance it to leave a Roth to the ones with higher incomes, and the tIRA to the ones with lower income. Balance as needed with taxable account. Something along those lines. You might find that's not worth the trouble, but it is a possible solution.

 

[RockyMtn]

an fyi the Federal Estate tax exemption for a married couple is $22.8 million as of now. Keep in mind this amount will expire in 2025 and fall back to the $11 million you mentioned, more or less.

Some folks are increasing gifting over the next six years in anticipation that any gifts given over the post 2025 rate will be grandfathered as acceptable and non taxable.

 

[Dtail]

That's not the way we play... in my house you have to earn your way and live with consequences of your decisions.

I know your reference and it is the same with my older DS.

 

[pb4uski]

I agree in theory. I have a question about practice.

What if there are three beneficiaries (adult children) who have different marginal tax rates? Average them, I guess?

What if the beneficiaries will have different marginal rates over time? Currently two of the three are working and drawing incomes, but when they retire they might drop a bracket or two.

Any more specific advice on these two points? Thanks.

In that case it is a judgement call.

In our case, DD & DSIL are 22% and DS is 12%.... and we generally do Roth conversions to the top of the 12% tax bracket but not into the 22% bracket... so DD benefits and DS is indifferent so it works out. Looking forward, I don't see DD/DSIL or DS' margina rates changing much.

 

[SecondCor521]

In that case it is a judgement call.

In our case, DD & DSIL are 22% and DS is 12%.... and we generally do Roth conversions to the top of the 12% tax bracket but not into the 22% bracket... so DD benefits and DS is indifferent so it works out. Looking forward, I don't see DD/DSIL or DS' margina rates changing much.

That makes sense.

I'm one of the three kids. I know what my and my Dad's brackets are and might be, but not my siblings except in a general sense.

@RB, your solution would work but is too fiddly for my taste. Thanks for the suggestion, though.

 

[gwraigty]

I agree in theory. I have a question about practice.

What if there are three beneficiaries (adult children) who have different marginal tax rates? Average them, I guess?

What if the beneficiaries will have different marginal rates over time? Currently two of the three are working and drawing incomes, but when they retire they might drop a bracket or two.

Any more specific advice on these two points? Thanks.

I don't think you should try to account for this. We went from the 15% bracket to the 25% bracket for 5 years while taking RMDs from an inherited IRA. We dropped back down for awhile after that, but at some point my husband's salary alone put us into the 25% tax bracket. You just never know what life events will take place to change those brackets up or down. In our case, I was still grateful for the inheritance, despite having to pay higher taxes on it than my late father had.

 

[MichaelB]

Another option to keep in mind - if there are grandchildren- is 529 accounts for their higher education expenses.

Edit to add - if the children have room for additional retirement saving and are also funding college accounts, contribution to the college fund frees money they can contribute to their own tax deferred retirement, which has the advantage that RMDs do not begin until they retire.

 

[audreyh1]

An additional strategy would be to gift money to your kids while you are alive. I believe the limit now is $15K per person, so you and your wife could gift each kid up to $30K, and if they are married, $60K to the couple. I don't fully understand the ramifications of exceeding the limit if you are going to be under the $11M threshold. I know that if you are going to be over that, the additional amount reduces that threshold.

The ramifications are mainly filing paperwork. Yes, it reduces the estate exemption. But it’s just paperwork if your estate is below that exemption.

 

[Golden sunsets]

Note the current pending legislation described here:

http://www.early-retirement.org/forums/f28/rmd-going-to-72-a-97142.html

Assuming that some version of the bill changing RMD age and the limitation on stretch tIRA's passes, that fact might significantly change the tax effects of inheriting a tIRA.