Leaving assets to heirs...better taxable accounts versus IRA's?

[MrLoco]

This is about leaving a legacy to children/grandchildren. It looks like the IRS will soon require any non spouse inherited Traditional IRA's to be liquidated by the beneficiary either as a lump sum or under the 5 year rule....no more stretch IRA's where the beneficiary could "stretch" the proceeds from a Trad. IRA over their lifetime.

I am now thinking that it may be better from a tax perspective (for my heirs) if I begin spending down from the Trad. IRA before 70 1/2 ( before RMD's) for retirement income and try to preserve my taxable assets for my heirs. My thinking is that beneficiaries will still receive ( unless the IRS also changes this rule) a stepped up cost basis on assets within a taxable account which could be substantial if equities have appreciated over a 40 year period.

Understanding that estate taxes will be due on taxable and tax deferred assets left to heirs , but by spending down assets in a Traditional IRA over my lifetime , I would not be leaving a $2 million Traditional IRA to my children/grandchildren which would need to be liquidated over 5 years creating a huge tax burden and money grab by Uncle Sam.

What is your thinking on this strategy?

By the way ....I am doing Roth conversions but no way will I be able to convert the entire Trad IRA to a ROTH over the next 10 years.

 

[Big_Hitter]

have you thought about getting a whole life policy?

 

[Disappointed]

I was thinking about this the other day. Would love to hear what others think.

 

[Act2]

I asked our family's accountant a version of this question recently. His answer was that of all the various financial assets, the last one you want to inherit is a Traditional IRA. The taxes will be paid by the one inheriting it, which reduces the value considerably.

Not saying it's not great to inherit a tIRA compared to not inheriting anything, just that if it's a choice between inheriting $100k but in different forms -- cash, stocks, bonds, or the tIRA -- the tIRA is worth less to the heir after taxes.

 

[meierlde]

Actually the income in respect of decedent suggests giving the ira to charity in preference to a taxable account. The Charity does not pay income tax on the IRA

 

[growing_older]

Inheritances outside of an IRA cannot get the "stretch" treatment, if that will still be allowed under any future tax law, but there is no step up basis issue in an IRA anyway. Anything that the inheritor withdraws from a Trad IRA is taxed as income at their then current income tax rate. This is certainly more tax than would be paid if the basis is stepped up on non-IRA assets, and it might be more even if the basis is not stepped up, depending on rates.

Sometimes paying big IRA Roth conversion taxes can be a tax win if the assets remaining (in the converted Roth instead of the Trad IRA) drop below the estate tax threshold. Inheriting a Trad IRA above the estate tax limit pays both estate tax and income tax on the withdrawals. An breath-taking combined tax rate that makes expensive tax planning worthwhile if you are in this situation.

 

[donheff]

Ignoring the estate tax limits (for most of us they too high to be relevant) it sounds like the Roth conversion question. If your taxes are low it makes sense to tap the IRAs now. If your taxes are high, tapping the IRAs early just ratchets of the taxes now - so you pay tax now and leave less to the kids or you leave more and the kids pay the tax. Has anyone modeled this to see at what brackets which works best? Another way of looking at this is what to do in your 80s if you are loaded up with tax deferred. Should you just take RMDs and leave the remainder to the kids or take multiples of the RMDs (incurring higher taxes) and leave more taxed funds to the kids? Sounds like it depends on your brackets vs the kids' brackets.

 

[Whisper66]

We have more assets than we need, much is in tIRA. We would like to pass on most of what we don't use/need to our kids. The plan we are progressing is to do yearly Roth conversions to help bring down the tIRA balance. Working to optimize taxes along the way using Roth conversion and living expense withdrawal plan based on ORP/3-PEAT. This will get a good chunk of our t-IRA into Roth IRA or spent by the time we pass. We are also gifting yearly the maximum amount we are comfortable with to our kids. Upper end of those gifts are limited by the tax free gift limits.

 

[Independent]

I asked our family's accountant a version of this question recently. His answer was that of all the various financial assets, the last one you want to inherit is a Traditional IRA. The taxes will be paid by the one inheriting it, which reduces the value considerably.

Not saying it's not great to inherit a tIRA compared to not inheriting anything, just that if it's a choice between inheriting $100k but in different forms -- cash, stocks, bonds, or the tIRA -- the tIRA is worth less to the heir after taxes.

Isn't the choice actually $100k in a tIRA vs. $70k in some other asset? (assuming my marginal combined federal and state income tax rate is 30%)

 

[gerntz]

It looks like the IRS will soon require any non spouse inherited Traditional IRA's to be liquidated by the beneficiary either as a lump sum or under the 5 year rule....no more stretch IRA's where the beneficiary could "stretch" the proceeds from a Trad. IRA over their lifetime.

Is this an IRS rule that the IRS can change alone or is this something Congress needs to approve and has? I see that Obama made this proposal in his last budget. Was it adopted? Seems to me Congress would need to act on this type of change or Obama wouldn't have needed to put it in a budget proposal but instead just directed the IRS to do. .

 

[GrayHare]

To answer this question one must know the tax rate now (for the original IRA owner) vs. the tax rate in the future (for the inheritor). The future tax rate requires a crystal ball, and right now -- with changes in handling of inherited IRAs being discussed -- that crystal ball is especially foggy.

 

[street]

You just can't win for winning. Lol I just isn't fair that the Gov. is after this money that is ours.

 

[growing_older]

Is this an IRS rule that the IRS can change alone or is this something Congress needs to approve and has? I see that Obama made this proposal in his last budget.

This proposal to eliminate the "stretch" of an inherited IRA has been proposed before and not enacted. It's anybody's guess if it will be enacted this time, or any of the following times it's proposed, or never. It seems premature to be reacting to a rule that doesn't exist yet, except as part of a general plan to diversify in the face of unknown future possible rule changes.

 

[RockyMtn]

right now my marginal rate at 28% is higher than my tira's beneficiary who is at 15%. I'm not doing any conversions until my rate comes down or theirs go up! I can true up the net net values by other bequests in the will.

 

[meierlde]

The idea of a stretch IRA does not really jibe with the basic purpose. My suggestion is rather that you must use the RMD schedule of the originator of the IRA. With the age 70 rmd used until the originator would have reached 70. (That would be 4% per year of withdrawal).

 

[gerntz]

This proposal to eliminate the "stretch" of an inherited IRA has been proposed before and not enacted. It's anybody's guess if it will be enacted this time, or any of the following times it's proposed, or never. It seems premature to be reacting to a rule that doesn't exist yet, except as part of a general plan to diversify in the face of unknown future possible rule changes.

Thanks. That's what I would have thought. No need for the scare tactic of this thread.

The other part of this is that if enacted, it ought apply only to future contributions, not to those contributed over existing rules.

 

[gerntz]

You just can't win for winning. Lol I just isn't fair that the Gov. is after this money that is ours.

Well, the tax portion isn't your money.

 

[audreyh1]

Don't forget the proposed $450,000 exemption. Below that stretch would still apply.

 

[street]

Well, the tax portion isn't your money.

I understand that totally. But dictating and changing just to please them is what I have issues with. When Gov. is looking for money they to benefit them they don't care if we worked hard to earn what we have they just want it. Lol

This change was a 26/0 vote for the change so it will be written up with proposed changes and voted on most likely this year and going into effect for year 2018. I sure hope this doesn't become law.

 

[Hermit]

You just can't win for winning. Lol I just isn't fair that the Gov. is after this money that is ours.

Well, the tax portion isn't your money.

The Gubmint just let you use it for a while. It was really theirs the year you made the income. Now you get to pay them back not only on the money you didn't pay them on, but also on what you earned with that money. Aren't they swell people?

BTW, without that incentive, I would probably be a lot closer financially to most other hermits!

 

[nun]

have you thought about getting a whole life policy?

You basically can't hold life insurance inside a qualified plan like an IRA. You'd have to cash out the IRA and buy the life insurance with after tax dollars, then the death benefit would pass to the heirs tax free. If you are only interested in the death benefit then you'd buy guaranteed universal life insurance, not whole life.

 

[EastWest Gal]

This is about leaving a legacy to children/grandchildren. It looks like the IRS will soon require any non spouse inherited Traditional IRA's to be liquidated by the beneficiary either as a lump sum or under the 5 year rule....no more stretch IRA's where the beneficiary could "stretch" the proceeds from a Trad. IRA over their lifetime.

I am now thinking that it may be better from a tax perspective (for my heirs) if I begin spending down from the Trad. IRA before 70 1/2 ( before RMD's) for retirement income and try to preserve my taxable assets for my heirs. My thinking is that beneficiaries will still receive ( unless the IRS also changes this rule) a stepped up cost basis on assets within a taxable account which could be substantial if equities have appreciated over a 40 year period.

Understanding that estate taxes will be due on taxable and tax deferred assets left to heirs , but by spending down assets in a Traditional IRA over my lifetime , I would not be leaving a $2 million Traditional IRA to my children/grandchildren which would need to be liquidated over 5 years creating a huge tax burden and money grab by Uncle Sam.

What is your thinking on this strategy?

By the way ....I am doing Roth conversions but no way will I be able to convert the entire Trad IRA to a ROTH over the next 10 years.

Federal estate taxes only kick in if your estate is over $5 million or so. However, you are correct about thinking about the tax consequences for your heirs of waiting until 70-1/2 to start tapping your IRAs. Your taxable account will be inherited at a stepped up basis, so if they decide to liquidate and invest what they inherit in a different way (as I did), there was no tax consequence in doing so.

The question is how to get your money to do the most work for you and your heirs. Maybe set up a spreadsheet, comparing the consequences of pulling more or less money from the tIRA and taxable accounts. Use data to estimate average growth, which of course will not be entirely accurate, but it's the best you can do, and see how it plays out?

Now I am responding to your first sentence: "This is about leaving a legacy to children/grandchildren." If you have enough to want to leave a legacy for children/grandchildren, then you may want to consider a gifting program that gives them access to some of the money now when it can be most useful instead of at an unknown date. If you live to 105 and your kids are 80 by the time they inherit, it seems the portfolio is wasted to some degree.

Gifting allows you to help those you love in meaningful ways that you choose. Pay for your grandchildren's education through a 529 plan set up for each of them. You name a successor for each 529 plan, so their parents then own the plan and can continue contributions if you pass away before your grandchildren's college years. You can gift your own children the same way. My son is opening a Roth IRA this year working part time, but we're gifting him the amount that matches what he will put into the Roth. If you have a lot of extra, gift your kids not in cash but in ETFs and mutual funds. If both of you are alive you can give $15,500 each without tax consequence. Of course these gifts will be included in calculation of your estate tax if you have a large estate, but the growth of the assets will not be included in the estate tax calculation.

I didn't mean to hijack the subject, but I was responding to the first sentence of the OP's post.

 

[45th Birthday]

If both of you are alive you can give $15,500 each without tax consequence. Of course these gifts will be included in calculation of your estate tax if you have a large estate, but the growth of the assets will not be included in the estate tax calculation.

I didn't mean to hijack the subject, but I was responding to the first sentence of the OP's post.

There is an annual gift exclusion amount that is separate from the lifetime estate and gift tax limit. For 2017, the annual exclusion is $14,000 per person to each individual, not $15,500. Certain gifts, like direct payment of medical and tuition expenses, are exempt from the $14,000 limit.

Any gifts that fall adhere to these rules are not included in the calculation of your estate tax no matter how large the estate.

The preceding is for federal taxes only.