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June 21, 2022 at 10:40 AM
What You Need to Know
- The Secure Act has made inherited IRAs less attractive for most non-spousal beneficiaries.
- Roth IRAs can be a versatile tool in both retirement planning and estate planning for clients.
- To pass a stock portfolio to heirs, a taxable account could be a better choice than a traditional IRA.
The Setting Every Community Up for Retirement Enhancement (Secure) Act upended inherited IRAs for most non-spousal beneficiaries. The 10-year rule for withdrawing from inherited IRAs eliminated the ability to stretch inherited IRAs for these beneficiaries.
The IRS recently released proposed regulations on this rule, under which IRA beneficiaries must take required minimum distributions in years one through nine if the account owner died after their required beginning date. According to expert Ed Slott, these rules are already effective.
Even without this seemingly new twist on the 10-year rule, the Secure Act has made inheriting an IRA less attractive for most non-spousal beneficiaries due to the bigger tax hit many beneficiaries will experience.
Look at the Whole Picture
IRAs are often one of the largest stores of wealth for many of your clients. As such, they are often a major part of their estate planning through the beneficiary designations on the account.
A key starting point is to look at your client’s overall situation as it pertains to both their retirement and their estate planning goals. The first concern with IRAs should be ensuring that your clients have sufficient assets to cover their retirement needs and the role that their IRAs play in satisfying these income needs for retirement.
Once their retirement needs are covered, take a look at your client’s estate planning goals. If they are married, spouses will generally be the primary beneficiaries of each other’s IRAs and other assets. Another important factor to consider is taxes, both your client’s tax situation and those of their non-spousal beneficiaries.
Roth IRAs
Roth IRAs provide a versatile solution on several fronts.
First, money in a Roth IRA is not subject to RMDs and can be withdrawn in retirement as and if needed by your client tax-free. Money in a Roth 401(k) can be rolled over to a Roth IRA and receive the same tax treatment. In all cases it’s important to ensure the five-year rule is satisfied first.
As far as inherited IRAs go, Roth IRAs can be passed to beneficiaries income tax-free as well. Non-spousal beneficiaries can take withdrawals from inherited Roth IRAs tax-free as long as the account holder had met the five-year rule prior to their death. The beneficiaries can then use this money as they see fit without having a chunk of the value eroded from the higher taxes that can result from the compressed 10-year withdrawal period.
It’s important to note that Roth IRAs are not exempt from federal estate taxes (traditional IRAs aren’t, either). By making Roth conversions, your client can prepay income taxes for heirs while reducing the size of their taxable estate. You will, however, want to work with your client to look at the relative tax implications of their paying the taxes now versus letting their beneficiaries deal with the taxes in the future.
Roth IRA conversions can be done over time, and you can work with clients to determine if their income will be lower than normal in a particular year, offering a good opportunity to do a conversion from a tax perspective.
This is a versatile strategy in that your client can convert any portion of their traditional IRAs that they choose. They can use the converted IRAs for their own purposes in retirement or earmark these assets for the next generation.
