These new tax laws have a lot of rabbit holes that we can go down.
I was recently discussing these with a colleague the new SECURE Act distribution rules and the lack of the stretch IRA provision.
The bottom line is there are extreme tax consequences for errors, particularly of retirement accounts that will need to be addressed in the coming decade and beyond.
When you leave assets behind for the children, there're often retirement assets that have not yet been taxed.
One of the things that came up as a potential opportunity but "rabbit hole" item is a nonequal distribution of assets to the next generation based upon their taxes.
This is a complicated option, but some attorneys that we're working with are starting to insert flexibility into estate plans that enables trustees to use discretion on distributing assets to beneficiaries adjusting for relative tax impacts.
This opens up the potential to distribute more taxable assets to the child in the lower tax bracket and lesser nominal lower-tax assets or tax-free assets to the child in the higher tax bracket, effectively arbitrating the tax experience for the descendants, increasing the assets that pass to both children and decreasing the assets that pass eventually to the government.
But I love my kids equally?! Sure you do, but would you want them to get together and try and reduce the family taxes together?
Pretend you have two children, one who is a schoolteacher making $50,000 a year and another who is a specialty physician making $500,000 a year, their tax situation is dramatically different.
If you expect for simplicity's sake to leave behind $1,000,000, composed of half retirement accounts, and half other assets like your home, or after-tax investment accounts.
The teacher might be paying a marginal Federal and State taxes of say 20%, and the doctor might be paying 45%.
So if you leave each of them half of all the assets, they would each get about $250,000 tax-free and $250,000 minus their marginal tax rate, so $200,000 and $137,500 respectively.
This totals to $837,500.
But what if you solved for the least amount of taxes possible between the two?
Leave the taxable retirement account to the teacher, and most of the other money to the doctor.
The teacher gets $500,000 minus their tax rate of say 25% or $375,000; this is higher because their income brackets might change, so always be sure to check with your CPA before doing anything like this.
Then we equalize the rest of the money. The tax-free bucket still has $500,000, and the after-tax value of the IRA of $375,000 = $875,000.
Then $875,000 / 2 = $437,500.
So the schoolteacher gets the $500,000 IRA which is worth about $375,000 after the eventual taxes, plus (437,500 – 375,000) $62,500 of the tax-free account.
The doctor gets $437,500 of the tax-free account.
This could potentially save the family (875,000 - $837,500) $37,500 on $1,000,000 by just doing some asset positioning and tax work with your CPA.
This is a complicated but a potential opportunity as we've seen many clients with very different income ranges for their children.
Commonly, our clients are interested in steps that they may take to reduce taxes and increase the amount of money that they leave to their loved ones.
If you'd like to discuss this, please first check with your attorney, but we'd be happy to brainstorm a little bit around it as well.
Thanks for taking a look!
Tom