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Should My Family Worry About the New Inherited Retirement Rules?

Should My Family Worry About the New Inherited Retirement Rules?

| December 22, 2019
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Gang, I'm really worried.

This new tax law that is coming out has the potential to impact your family and the taxes that you pay, dramatically.   

If you spent your whole life saving in a traditional 401(k), or pension plan and IRAs, and saved a lot of money, this message is for you.   

This message is also even more so for you if your children are traditionally successful with high-earning households.   

The premise of the 401(k) savings program was that you would take income and defer it until you were retired with a lower income.  This is effectively tax arbitrage or generally a risk-free bet with the government to encourage you to save for your retirement so you're not destitute later in life.   

Up until now, these lifetime savings vehicles were held with continued reverence when they were passed down to the next generation.  This meant that for someone inheriting a retirement account, perhaps a few children, for example, would not have to take the money out quickly.   

There is a variety of reasons for this, but one is that when a parent passes away, often the children are in their peak earning yearstypically (and hopefully) ages 50 to 60+. 

The new rule requires that inherited retirement accounts be withdrawn from the account and taxed within 10 years! 

This has the impact of taking your IRA and dividing it by 10 and adding it onto the ordinary income tax of your descendants.   

The thing that very few people are talking about is that the tax rate your descendants might pay on your lifetime savings could be dramatically higher than the deferral rate that you benefited from when you put the money to work! 

This can pull the rug out from a great portion of your after-tax spendable savings.   

Imagine, for a moment, a person passing away with a $2 million IRA with a couple of kids. 

Each child will theoretically have to distribute about $100,000 per year for a decade.  We're looking at possibly being in the 37% or so tax bracket federally, plus perhaps another 10% from the state.   

In some cases looking at paying almost 50% in taxes!   

This tax change is an all-hands-on-deck type situation if you have this scenario.

The good news is some things can be done.  The bad news is none of them are easy. 

Though, if you are staring down a 40% to 50% marginal tax rate, you may want to accelerate income.   

Accelerating income also gives us the ability to put the money into a Roth IRA, which is tax-free upon distribution. 

Keep in mind that your retirement money in traditional retirement accounts always has an embedded tax sitting on it, so if you have $1 million, you don't have $1 million of spendable assets - you have maybe $700,000.   

If you convert that money at a lower tax rate earlier, say, for example, at 30%, and the tax rate experience later would've been 50%, then you just saved 20%. 

Even though you had to prepay those taxes, the algebra is linear. If you save 20% of taxes on that net distribution, it can be a great thing.   

Furthermore, the Roth IRAs are not subject to mandatory required distributions when you're alive, which can reduce the taxable income that you are forced to take.   

Enough about that.  I think you get the gist.   

 

We've got time to plan, but if you want to talk about this, please let us know.   

We'd be happy to brainstorm with you about how to maximize the net spending power for your family.   

Please verify any and all moves with your CPA.  This is not only new but complicated, and there are a lot of moving parts. 

 

Thanks for taking a look! 

 

Tom 

 

This article represents opinions of the authors and not those of their firm and are subject to change from time to time, and do not constitute a recommendation to purchase and sale any security nor to engage in any particular investment or legal strategy. The information contained here has been obtained from sources believed to be reliable but cannot be guaranteed for accuracy.   

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