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Is it better to leave a taxable account as an inheritance than an IRA account?
Old 01-01-2018, 07:55 PM   #1
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Is it better to leave a taxable account as an inheritance than an IRA account?

We currently fund our retirement through our taxable account (dividend, interest, cash) and leave our IRA account to grow tax deferred.

Since there is a step up in value for the taxable account there should be no capital gain tax while an IRA account will result in a mandatory distribution and taxes must be paid.

Even though we have to pay taxes upon withdrawal, we can control the withdrawal amount to minimize our taxes from The IRA account while the recipients do not have that option.

How are you guys handling this?
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Old 01-01-2018, 08:06 PM   #2
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I don't know but can't wait to read what people think. Good planning.
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Old 01-01-2018, 08:18 PM   #3
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I don't know but can't wait to read what people think. Good planning.
This partly depends on the ages of the beneficiaries assuming they are one generation down. All inherited IRAs have an RMD with a different table, so you would have to look up the difference in the RMD due to the age difference. It of course also depends on where you think tax rates will be in the future, (IMHO they have only one way to go, up). Yes all distributions pay tax at the regular income tax rates ( no capital gains treatment, you pay tax on the total withdrawal, but if you withdraw in kind you get a reset basis as part of the deal)
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Old 01-01-2018, 08:19 PM   #4
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I am interested in the responses to this, as we have a similar situation.

They all have merit. While I might desire to leave an inheritance, should I prepay the taxes? Ultimately someone, at some tax rate, will pay taxes on the tax deferred account.

To show my confusion, we are entering year three of retirement. We did #3, the first year, # 2 the second, and I am thinking of # 1 for next year.

In the grand scheme of things, I'm not sure it matters much, and the BEST plan just depends on when you meet your maker. Any one got a good crystal ball?
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Old 01-01-2018, 08:35 PM   #5
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When managing for your own retirement, the general idea is to try to spread taxes evenly over your life time. Don't pay 28% one year, and 10% the next, but rather try for 15/12% over both, if possible, and subject to other factors.


If trying to optimize for heirs, it becomes trying to do the same over two lifetimes, so it also depends on your heirs' projected tax rate.


If it fits your situation, my thought would be to live off taxable by selling off losers and small winners, and also taking the dividends in cash rather than reinvesting. Then top off your 12% bracket with Roth conversions. This is what I do, and I hope not to leave a tIRA.
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Old 01-01-2018, 11:31 PM   #6
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Over the last few months, I have started to re-think this as well.

I'm 57 and my kids are currently 16/13. My estate is set up to get them launched, but no significant money would pass to them until they are in their late 20's-early 30's. By then, they will have had to fend for themselves long enough to figure out how to have a decent life with their own earnings.

Barring an extend run with boats, hookers and blow, it's likely there will be a not-insignificant amount of money left behind, no matter when that is. If it's tomorrow, I will have missed out on a lot of hookers and blow, and they won't have to work very hard past their 30's

Having thought about different scenarios, I'm beginning to think it will be better for them if I draw down the IRAs (Trad primarily) and preserve the taxable account (~40% of investments).

My concerns are:
1. While they are showing good money sense for their ages, I don't know how they will handle a regular paycheck. Lot of reasons to be hopeful, but can't be certain.
2. If I expire in less than 10-ish years, the RMDs they are forced to take will be helpful, but the amounts could be low enough they consider it nice and spend it instead of investing it. No way to know now.
3. If my demise is after RMDs start for me, they will both be independent. The money habits will be clear before then, and if they are not to my liking, I can change the estate plan along the way. Either way, they have to take RMDs from whatever is left.

My current thought is to do Roth conversions when I can at lower tax rates, consider drawing SS at 62, and draw down the tIRA otherwise. All with the goal of preserving the taxable account assets.

At this point, I think it's better for them to be staring at a bigger pile with plans in place to manage that money than to have it dribble out at a rate that's enough to buy a new car every few years. Think it's a way to make a meaningful amount of money "meaningful" as opposed to being used to pay off the monthly credit card bill of a free-spending spouse (should that happen)

I'm not completely satisfied with this approach, but it will work until I come up with a better one . Fortunately, I'm happy with the current estate plan, can't tap the IRA without penalty yet, and the SS decision is a few years away.

In my case, no decisions to make now, and I'm glad for that.
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Old 01-02-2018, 10:39 AM   #7
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IMHO, the best option would be to leave Roth IRAs. Next would be taxable accounts and finally, traditional IRAs. So, a good plan would be to convert your traditional to a Roth, as long as the taxes on the conversions are favorable. That was my original plan, but it doesn’t appear the tax situation will be favorable for us. So for now, once RMDs kick in, excess income will go in taxable accounts with a TOD.
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Old 01-02-2018, 10:47 AM   #8
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Don't know if charitable giving is part of your exit plans, but if so, you can designate a charity as the beneficiary of (some of) your tIRA. The charity won't pay taxes on what they get.
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Old 01-02-2018, 10:55 AM   #9
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When my dad passed away, he had enough money in the estate to trigger an estate tax. In NYS, where the was a resident at the time of his death, anything over a million is taxed at 30, or 33 % (something like that, I don't remember the exact %),

AND...it's the same amount due whether or not those dollars are in an IRA or after tax accounts. So, in essence, if hypothetically there was a million $ in IRAs,subject to the estate tax, the estate pays that 300K, even though when the heirs actually get the money, they have to pay tax on the distributions, again.

Given that someday the govt. may, if they haven't already, do away with the "Stretch" IRA option, that represents a heck of a tax hit.
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Old 01-02-2018, 11:08 AM   #10
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Don't know if charitable giving is part of your exit plans, but if so, you can designate a charity as the beneficiary of (some of) your tIRA. The charity won't pay taxes on what they get.
That is a very good point.
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Old 01-02-2018, 11:16 AM   #11
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All else being equal, plus assuming better means more after-tax money for the beneficiary, and that future taxation is similar to current, the ordering is

1) Roth IRA
2) regular investment account
3) Traditional IRA

Withdrawals from the Roth are untaxed to the beneficiary. A regular investment account gets a step up in basis plus is subject to lower cap gains taxes. Withdrawals from a traditional IRA are taxed as ordinary income, which means the highest rates.
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Old 01-02-2018, 12:21 PM   #12
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All else being equal, plus assuming better means more after-tax money for the beneficiary, and that future taxation is similar to current, the ordering is

1) Roth IRA
2) regular investment account
3) Traditional IRA

Withdrawals from the Roth are untaxed to the beneficiary. A regular investment account gets a step up in basis plus is subject to lower cap gains taxes. Withdrawals from a traditional IRA are taxed as ordinary income, which means the highest rates.
I fully agree this is the best for the beneficiary. As mentioned by Runningbum, optimization over two lifetimes is more difficult.

There is no way we can convert all of our tIRA's to Roth, while staying in the 12% (formerly 15%) bracket. Converting in the 22% bracket could make some sense. That is likely where we will be when RMD's kick in so it is a wash while we are both on the planet. But when one us goes, the survivor will be at least in the 24% bracket and possibly in the 32%.

In the grand scheme of things, we are talking about saving 2-10% in marginal taxes (if we convert at 22%), when one of us is 75-80, and will leave DS a larger tax free inheritance, because we paid it for him.

I think we will stay at maxing out the 12% bracket, for now. At the risk of being a Market Timer, I might consider going higher if there is a big market pullback.
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