Non-Spouse Inherited 401(k) and IRA Withdrawal Requirements

[tmm99]

My DH and I still don't have wills, but we're finally getting them done - talking to an estate lawyer and trying to get a bank to be our trustee, etc.

So during my research, I realized that a new rule was put in place in December of 2019 that non-spousal beneficiaries who inherit a 401K/IRA will have to drain the account within 10 years of the death of the original account holder (with some exceptions). My tax-deferred accounts are about 70% of my total assets, so it's not small (to me). Once DH and I die and the money goes to a non-spouse, and if this person has to take out at least 10% of it, that will cause a pretty big hit.

I'm sure many of you knew this particular rule, but it was news to me. I was being very stingy about taking partial distributions from my tax-deferred accounts because of the tax hit. I know many of you are doing Roth IRA conversions but as a Canadian resident, I don't have that option anymore, so now, I am thinking of just taking more out of my tax-deferred accounts, take the tax hit and then reinvest the extra in my after-tax account. Actually though, I'm changing my mindset a little - I should spend more money even if it costs more money (taxes) to do so.

I'm just rambling LOL.

What are you doing in your case?

 

[statsman]

I figure any money we leave after our passing will be extra for the heir(s). Yes, they will have a bigger tax bill, but they will also have more money. As such, I don't think how much tax they may end up paying will alter our withdrawal plans.

You just never know what the future holds. You and/or your DH could live a long time, and in that case it might be better tax-wise for the two of you to keep the money in tax-deferred accounts.

If you have so much money that you can't envision spending it all no matter how long you live, you might want to start gifting some of it now to spread out the tax hit on the heirs.

 

[tmm99]

I figure any money we leave after our passing will be extra for the heir(s). Yes, they will have a bigger tax bill, but they will also have more money. As such, I don't think how much tax they may end up paying will alter our withdrawal plans.

You just never know what the future holds. You and/or your DH could live a long time, and in that case it might be better tax-wise for the two of you to keep the money in tax-deferred accounts.

If you have so much money that you can't envision spending it all no matter how long you live, you might want to start gifting some of it now to spread out the tax hit on the heirs.

Thanks for your input

Yeah, maybe it's OK for them to take the hit like you say. How they have it set up is certainly better than having to drain everything in one shot.

I guess it's always a balancing act. We never know if we need a lot of money at the end of our lives too, so we can't go all crazy giving away money now, but we will definitely be doing more of it.

 

[rodi]

Like statsman - that will be my heirs' problem. LOL. They'll still have plenty extra after paying the taxes.

 

[EastWest Gal]

Let the heir(s) pay the taxes. They will still be way ahead than they were previously. It is emotionally easier paying taxes on inheritance, because you did nothing at all for that money, and many times an inheritance, after taxes, is life-changing. My inheritance changed my life within a few years. It did not change my lifestyle, but put me into FI category early. RE was a different process. And it got my sister out of working 50% overtime to pay the bills, which eased my mind greatly! She is FIRED within 6 weeks and I am delighted.

This is why I am establishing a family gifting program, because I want the people in my life not to freak out when a corporate bully takes away one's livelihood, as what happened to me 18 years ago.

 

[tmm99]

I didn't say it was an heir who will be receiving the inheritance, but I see everyone's point. Who cares about them having to pay taxes - at least they're getting something for nothin'! And I think gifting while alive is a good idea as well. You'll get to see the joy in their faces.

Thank you all for your comments!

 

[rodi]

I didn't say it was an heir who will be receiving the inheritance, but I see everyone's point. Who cares about them having to pay taxes - at least they're getting something for nothin'! And I think gifting while alive is a good idea as well. You'll get to see the joy in their faces.

Thank you all for your comments!

Heir.... Beneficiary... semantics. Some non spousal person or organization is inheriting or benefitting.

 

[tmm99]

Heir.... Beneficiary... semantics. Some non spousal person or organization is inheriting or benefitting.

Yeah, OK, LOL. Got it! I imagine most people designate their children or relatives as their beneficiaries so when people say "heir", they usually mean just that. So with no children of my own and without any relatives left that I even communicate with except for my mom and my aunt (as I moved out of my native country when I was still a teenager), the word "heir" sounded a bit out of place in my case, is all. That's why I kept on saying "non-spouse".

 

[Alan]

There must be a different tax arrangement between Canada and the USA than there is between the UK and the USA because even as a resident in the UK I have been doing Roth conversions, not to minimize be taxes for the heirs but to minimize for myself and my wife. I finished converting all my IRA money to a Roth before I started to collect UK and USA SS, and also avoiding the extra income from RMDs in due course.

Roth withdrawals are tax free in both the UK and USA as per the Tax Treaty.

 

[target2019]

Blow that dough.
Die with zero.
Those threads take on the dilemma you mention.

 

[tmm99]

There must be a different tax arrangement between Canada and the USA than there is between the UK and the USA because even as a resident in the UK I have been doing Roth conversions, not to minimize be taxes for the heirs but to minimize for myself and my wife. I finished converting all my IRA money to a Roth before I started to collect UK and USA SS, and also avoiding the extra income from RMDs in due course.

Roth withdrawals are tax free in both the UK and USA as per the Tax Treaty.

You are lucky!!!!! Once you live in Canada, CRA won't recognize Roth IRA as a tax-free investment account if you add money into your Roth IRA while you're a Canadian resident. You actually have to write to them and ask them to elect the account as a tax-free vehicle after telling them which date you last added money to it and which date you moved to Canada. They then write back and tell you if they approve it as a tax-free account or not. My cross-border accountant thankfully warned me about this before my move.

Canada has something similar called TFSA (Tax Free Savings Account) and as a US citizen, it won't be tax-free, so there's no reason for me to use it :-( In addition, CRA taxes 85% of SS regardless of your income bracket. They try to hit you with taxes every way they can LOL.

So I guess Canada doesn't have the same rules as the UK in regards to the US. Can you still trade in your US after-tax account? I cannot do that as a Canadian citizen. I can only sell what I have and that's it. Fidelity advisors aren't allowed to help me with my asset allocation, etc in my tax-deferred accounts either.

It also seems quite difficult to try to set up a trustee who would manage a Candian resident's 401K in the US for the same reason. All the trustees I talked to so far said they would have to take all the money out at once (a huge tax hit!) and bring it over to Canada to manage. The only place I found that said they could do a like transfer without taking all the money out all at once was Raymond James as they have corps in both countries, but they want me to do the transfer while I'm alive (they only do estate service work for their wealth management clients), so no...

 

[tmm99]

Blow that dough.
Die with zero.
Those threads take on the dilemma you mention.

Yeah, I was just reading the Die with Zero thread. I should get the book...

 

[RunningBum]

I understand that heirs ought to be grateful for whatever they get, but that doesn't mean that I should totally ignore their taxes. I optimize for myself first, and then if it has no effect for me, I optimize for my heirs.

I also second the idea to gift now, while I can see the effects. I've been gifting my son $15K or whatever the max has been each year without filling out estate tracking forms for a few years. Sometimes he's used that for whatever, I don't ask, but mostly he has been investing it to eventually buy a house when he felt settled where he lived. Last week he just got his offered accepted on a house, and can put 20+% down, enough to qualify on his relatively low wage income, and to avoid PMI. He is totally psyched about having a slightly lower monthly payment on the house than he paid in rent, for a much improved place to live in almost every way. And I was the first he called when his offer was accepted. A few days later the feeling still is really good for me.

Regarding details for a Canadian resident, sorry, I got nothing.

 

[Alan]

You are lucky!!!!! Once you live in Canada, CRA won't recognize Roth IRA as a tax-free investment account if you add money into your Roth IRA while you're a Canadian resident. You actually have to write to them and ask them to elect the account as a tax-free vehicle after telling them which date you last added money to it and which date you moved to Canada. They then write back and tell you if they approve it as a tax-free account or not. My cross-border accountant thankfully warned me about this before my move.

Canada has something similar called TFSA (Tax Free Savings Account) and as a US citizen, it won't be tax-free, so there's no reason for me to use it :-( In addition, CRA taxes 85% of SS regardless of your income bracket. They try to hit you with taxes every way they can LOL.

So I guess Canada doesn't have the same rules as the UK in regards to the US. Can you still trade in your US after-tax account? I cannot do that as a Canadian citizen. I can only sell what I have and that's it. Fidelity advisors aren't allowed to help me with my asset allocation, etc in my tax-deferred accounts either.

It also seems quite difficult to try to set up a trustee who would manage a Candian resident's 401K in the US for the same reason. All the trustees I talked to so far said they would have to take all the money out at once (a huge tax hit!) and bring it over to Canada to manage. The only place I found that said they could do a like transfer without taking all the money out all at once was Raymond James as they have corps in both countries, but they want me to do the transfer while I'm alive (they only do estate service work for their wealth management clients), so no...

I can trade and buy in my after tax Roth account, which I do to rebalance each year. The UK also has a TFSA which the US does not recognize so there is nowhere except within a UK private pension plan to hold equity and bond funds without the IRS treating them as PFICs.

SS is only taxed in the UK, not the US, and the UK taxes all of it. The UK version of SS is also only taxed in the UK. It’s all fun and games figuring it out.

 

[tmm99]

I can trade and buy in my after tax Roth account, which I do to rebalance each year. The UK also has a TFSA which the US does not recognize so there is nowhere except within a UK private pension plan to hold equity and bond funds without the IRS treating them as PFICs.

SS is only taxed in the UK, not the US, and the UK taxes all of it. The UK version of SS is also only taxed in the UK. It’s all fun and games figuring it out.

Wow, I should consider myself lucky!

Cross-border taxes are too complicated for me, so I get the help of a specialized cross-border tax accountant...

 

[tmm99]

I understand that heirs ought to be grateful for whatever they get, but that doesn't mean that I should totally ignore their taxes. I optimize for myself first, and then if it has no effect for me, I optimize for my heirs.

I also second the idea to gift now, while I can see the effects. I've been gifting my son $15K or whatever the max has been each year without filling out estate tracking forms for a few years. Sometimes he's used that for whatever, I don't ask, but mostly he has been investing it to eventually buy a house when he felt settled where he lived. Last week he just got his offered accepted on a house, and can put 20+% down, enough to qualify on his relatively low wage income, and to avoid PMI. He is totally psyched about having a slightly lower monthly payment on the house than he paid in rent, for a much improved place to live in almost every way. And I was the first he called when his offer was accepted. A few days later the feeling still is really good for me.

Thank you for your post. Yes, what you said makes sense - optimize for myself first then for my beneficiaries.

I'm leaning toward gifting while alive more and more. The big reward for me would be that I could get to see the effect firsthand.

 

[Alan]

Thank you for your post. Yes, what you said makes sense - optimize for myself first then for my beneficiaries.

I'm leaning toward gifting while alive more and more. The big reward for me would be that I could get to see the effect firsthand.

We have been gifting to our children this last 4 years and will continue to do so. Having almost lost our son in April spurs us on to give while we can. The UK gifting rules are extremely generous but of course could change at any time.

 

[MichaelB]

+1@RunningBum and Alan

Optimize based on your own tax, then if it makes sense, theirs for inheritance. We’re also gifting to the kids, undeserving as they are ), just kidding) and our gifts go mostly to their retirement savings, the rest to their investment account.

 

[tmm99]

We have been gifting to our children this last 4 years and will continue to do so. Having almost lost our son in April spurs us on to give while we can. The UK gifting rules are extremely generous but of course could change at any time.

Yes, I remember about your son. I can imagine how a serious event like that can help us put things in perspective and figure out our priorities.

You can gift up to £3,000 per year tax-exempt, right? (You said it's "extremely generous"?) I believe it's $15K in Canada...

 

[Alan]

Yes, I remember about your son. I can imagine how a serious event like that can help us put things in perspective and figure out our priorities.

You can gift up to £3,000 per year tax-exempt, right? (You said it's "extremely generous"?) I believe it's $15K in Canada...

In the UK you can gift a lump sump sum as large as you wish and then a 7 year clock starts ticking. The potential inheritance tax starts at 40% but after 3 years it drops 10% per year until after 7 years there is no potential tax owed ever provided I and my wife live 7 years beyond the gift. Also, you can gift as much as you can afford out of income from wages, pensions, annuities and dividends, just have to maintain a spreadsheet recording income and expenses that the executor of the will may file.

 

[tmm99]

In the UK you can gift a lump sump sum as large as you wish and then a 7 year clock starts ticking. The potential inheritance tax starts at 40% but after 3 years it drops 10% per year until after 7 years there is no potential tax owed ever provided I and my wife live 7 years beyond the gift. Also, you can gift as much as you can afford out of income from wages, pensions, annuities and dividends, just have to maintain a spreadsheet recording income and expenses that the executor of the will may file.

Thank you, Alan. I didn't know anything about this 7-year rule. I've just read one article - Very interesting! So you'd better survive at least 7 years from the date of the gift; or you'll end up paying inheritance taxes (depending upon how many years it's been since the death date...)

 

[tmm99]

+1@RunningBum and Alan

Optimize based on your own tax, then if it makes sense, theirs for inheritance. We’re also gifting to the kids, undeserving as they are ), just kidding) and our gifts go mostly to their retirement savings, the rest to their investment account.

Thank you, Michael. Good that your children are making very wise choices. I wasn't given much gift money myself when I was younger, but the small amount I received, I did save and didn't splurge on frivolous things...

 

[Alan]

Thank you, Alan. I didn't know anything about this 7-year rule. I've just read one article - Very interesting! So you'd better survive at least 7 years from the date of the gift; or you'll end up paying inheritance taxes (depending upon how many years it's been since the death date...)

I first found out about the 7 year rule in about 2016 when PM David Cameron received a £500,000 gift from his mother so it made the news and I decided that I needed to know more about Inheritance Tax. Another good bit of news is that retirement accounts are exempt from IHT.

 

[tmm99]

I first found out about the 7 year rule in about 2016 when PM David Cameron received a £500,000 gift from his mother so it made the news and I decided that I needed to know more about Inheritance Tax. Another good bit of news is that retirement accounts are exempt from IHT.

Thanks, Alan! I need to tell my DH about all this...