An ongoing series of changes from Congress has estate planning lawyers paying close attention to what’s going on in Washington. The IRS recently proposed more changes to IRAs, details of which are explained in this recent article “The Secure Act Changed Inherited IRA Rules. What’s an Advisor to Do?” from Think Advisor. Every time the laws change, new opportunities and new restrictions are presented.
Having to empty inherited IRAs within ten years makes the IRA less attractive from an estate planning perspective. Several alternatives exist if your legacy plan includes leaving significant assets through an IRA. First, take a more extended look at your estate through an estate planning, inheritance, and tax planning lens. Do you have enough funds to pay for your planned retirement without the IRA? If not, the following steps may not apply to your situation.
What are your estate planning goals? If married, your spouse is probably the beneficiary on retirement accounts and life insurance policies. If you don’t know who is your intended beneficiary, now is the time to check to be sure your beneficiaries are up to date.
Taxes come next for you, your spouse, and any non-spousal heirs. Withdrawals from traditional Roth IRAs are not generally taxable. Will anyone (besides your spouse) receiving the IRA be able to pay the taxes, or will they need to use the assets in the IRA to pay taxes?
The Roth IRA provides an excellent alternative to getting hurt by the SECURE Act’s 10-year restriction on inherited IRAs. Taxes are paid when the account is funded, there are no withdrawal requirements, and the accounts are free to grow over time. Money in a traditional IRA may be converted to a Roth IRA, although you will be paying taxes on the conversion.
The Roth IRA conversion has a five-year requirement. Funds must be converted and remain in the account for five years before the more flexible Roth rules apply.
Roth IRAs may be passed to beneficiaries income-tax-free. Non-spousal beneficiaries can take withdrawals from Roth IRAs tax-free as long as the five-year rule has been met. The beneficiaries can then use their inheritance as they wish, without the funds being diminished by higher taxes resulting from taking out large sums in a relatively short time.
Roth IRAs are not exempt from federal estate taxes, just as traditional IRAs are not exempt. However, by making the conversion and paying the taxes up front, you can at least minimize income taxes for heirs, even though you can’t eliminate the federal estate tax.
Rather than do the conversion all at once, consider doing a Roth IRA conversion over time and figure out with your Financial Planner or CPA the best way to minimize your tax burden and adjust it for years when your income is lower.
This flexible strategy with Roth IRAs can be used with all or a portion of the IRA, protecting part of the IRA for the next generation while using part of the funds for retirement. Your estate planning attorney will help you determine the best way forward to meet your current and future needs.
Reference: Think Advisor (June 21, 2022) “The Secure Act Changed Inherited IRA Rules. What’s an Advisor to Do?”