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Don't Leave Retirement-Account Tax Surprises to Clients’ Heirs

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Now is a great time for advisors to be discussing taxes and retirement planning with their clients if they haven’t already done so, according to Leslie Geller, a Los Angeles-based wealth strategist at Capital Group with 15 years of industry experience.

One major reason to review the tax implications of passing down retirement accounts now, for instance, is because of the Secure Act that took effect in 2020, she noted.

Prior to joining Capital Group, Geller was a partner at Elkins Kalt Weintraub Reuben Gartside, where she advised high- and ultra-high-net-worth clients on all matters related to taxation, wealth transfer and family governance.

By email, we asked Geller a series of questions on what she suggests advisors do now for their clients when it comes to taxes and their retirement plans and portfolios.

THINKADVISOR: Why should advisors review the tax effects associated with passing down retirement plans after death with clients now?

LESLIE GELLER: One of the major reasons to review the tax implications of passing down retirement accounts now is because of the SECURE Act. Passing on retirement assets as an inheritance has always been tax inefficient, but it’s become even more of a concern because of this new legislation that took effect in 2020. Additionally, the IRS recently released proposed regulations to accompany the SECURE Act, and even though these regulations are not in final form, they indicate a general direction of travel.

Under the SECURE Act, most non-spouse beneficiaries who receive IRA accounts as an inheritance — upon the death of the owner of that account — will now be subject to the 10-year rule, meaning they must draw down the full value of the retirement account over 10 years (as well as pay the tax on these disbursements if it’s a traditional IRA). Previously, with proper planning, most investors who inherited retirement accounts could take distributions from the account over their remaining life expectancy.

For many families, this new 10-year rule may result in negative planning and/or tax consequences, so at the very least, a discussion around passing down retirement accounts, both traditional and Roth, is table stakes.

Advisors can flag to clients and their families the tax issues and uncertainties that they may face when passing down retirement assets at death. Advisors can also discuss the various “pre-death planning” options their clients have with respect to their retirement assets, with an eye towards minimizing uncertainty, and potentially future tax liability.

These options include everything from reevaluating beneficiaries and the division of qualified and non-qualified assets among beneficiaries, to large-scale Roth conversions and distributions far and above their RMDs.

What other tax-related issues should advisors be talking about now with their clients who are retirees and pre-retirees regarding their retirement plans/portfolios, and why?

For high-net-worth (HNW) clients, now is the time for advisors to keep wealth transfer discussions front of mind. This is particularly true for transitioning their wealth — such as retirement accounts — down to children in a tax efficient manner. Many clients do not realize that retirement accounts are considered part of their taxable estate upon death.

Currently the lifetime exemption from the estate and gift tax amount is in excess of $12 million per person, but it is scheduled to drop to around $6 million per person in 2026. At this level, many more HNW families will need to think about proactive wealth transfer planning, which can range from the very simple (e.g., paying tuition expense directly, funding 529s as wealth transfer vehicles) to the complex (e.g., GRAT programs, sales to defective grantor trusts, or spousal lifetime access trusts).

With inflation moving higher, advisors should also discuss with their clients any anticipated changes to the level of distributions that they’ll need from their retirement accounts. Will clients need more than the required minimum distributions (RMDs)? What will be the tax implication of potentially drawing down more?

One major consideration these days for clients that are anticipating needing to pull more out of their traditional IRA is liquidity to satisfy the accompanying tax liability. This tax liability is optimally paid from taxable funds, therefore planning for increased distributions from retirement accounts may also require some planning with non-qualified accounts.

Why should advisors encourage clients to plan for “major money moments” now, before they happen later this year for example, rather than after the money is in the bank?

There’s so much more flexibility and optionality if you do things before versus after, like with anything in life. A lot of the income tax mitigation techniques that allow for income tax deferral or income tax mitigation require pre-transaction planning; tax mitigation tools are much more limited after a transaction has been executed.

One example of this pre-transaction planning that we’re seeing a lot of right now is planning with respect to state income taxes. If someone lives in a high tax state and they’re about to have a big money moment, such as the sale of a business, advisors can help them implement trust structures in no-income tax states like Delaware or South Dakota, which can have huge benefits in the future. This type of state income tax planning can mitigate tax liability significantly, both with respect to the initial capital event and on a go-forward basis.

Another pre-transaction planning tool that we discuss frequently is the charitable remainder trust, which, among other tax benefits, can provide significant tax deferral upon a large capital event.

What should advisors be specifically discussing with their clients now about tax loss harvesting and why?

It’s very personal and unique to each investor, and there’s no general rule. It’s what makes sense for an investor right now, including what tax bracket they’re in, their current and expected income streams, tax planning goals, etc. Advisors need to have a bespoke conversation with each client to determine how best to approach tax loss harvesting.

It also depends on market valuations. Advisors need to discuss with their clients whether it makes sense to cash out and use losses now, versus holding on to an investment and hoping for a rebound in value over the next five to 10 years. You don’t want the tax tail to wag the investment planning dog; a lower tax bill this year may mean losing out on some serious appreciation down the road!

Advisors need to discuss questions like: does it make more sense to take the loss now to lower a client’s tax bill today at the potential cost of losing out on good investment opportunity down the road? It’s important not to get lost in the benefits of tax loss harvesting at the expense of a client’s future investment picture tomorrow.

What other tax-related issues are important for advisors to discuss with their clients now in terms of their retirement plans, investments, etc. and why?

I’ve been highlighting over and over in the conversations I have every day with advisors across that country that tax planning needs to stay front of mind. Many have let it drop down the list of priorities because last year’s proposed federal tax changes never ultimately came to pass. Helping clients plan for taxes is a powerful tool for advisors’ client relationships.

I also suggest keeping gifting conversations front of mind with high-net-worth families because of the organic growth and asset acquisition opportunities (both with the client and the client’s family) that this type of engagement provides.

Last but certainly not least, I suggest advisors ensure they have tax experts on their team whose understanding is equal to the level of assets of their clients. I’ve seen investors go through big capital events, make a lot of money on the sale of investment in a startup, for example, but still use a CPA who has never completed a gift tax return for a client.

Make sure you have experts and professionals that can grow with your clients as they grow and whose level of expertise is commensurate with their wealth is vital. If advisors don’t have relationships with tax professionals in their communities, now is a great time to forge those to add value to your practice.