What to Do with an Inherited IRA? – Annapolis and Towson Estate Planning

Most of us do not have to worry about paying federal estate taxes on an inheritance. In 2021, the federal estate tax does not apply, unless an estate exceeds $11.7 million. The Biden administration has proposed lowering the exemption, but even that proposal would not affect estates valued at less than about $6 million. However, you should know that some states have lower thresholds.

Kiplinger’s recent article entitled “Minimizing Taxes When You Inherit Money” says that if you inherit an IRA from a parent, taxes on mandatory withdrawals could leave you with a smaller legacy than you anticipated. With IRAs becoming more of a significant retirement savings tool, there is also a good chance you will inherit at least one account.

Prior to last year, beneficiaries of inherited IRAs (or other tax-deferred accounts, such as 401(k) plans) were able to move the money into an account known as an inherited (or “stretch”) IRA and take withdrawals over their life expectancy. They could then minimize withdrawals which are taxed at ordinary income tax rates and allow the untapped funds to grow. However, the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 stopped this. Most adult children and other non-spouse heirs who inherit an IRA on or after January 1, 2020, now have two options: (i) take a lump sum; or (2) transfer the money to an inherited IRA that must be depleted within 10 years after the death of the original owner.

Note that this 10-year rule does not apply to surviving spouses. They are allowed to roll the money into their own IRA and allow the account to grow, tax-deferred, until they must take required minimum distributions (RMDs), which start at age 72. If it is a Roth IRA, they are not required to take RMDs. Another option for spouses is to transfer the money into an inherited IRA and take distributions based on their life expectancy. The SECURE Act also created exceptions for non-spouse beneficiaries who are minors, disabled or chronically ill, or less than 10 years younger than the original IRA owner. Any IRA beneficiaries who are not eligible for the exceptions could wind up with a big tax bill, especially if the 10-year withdrawal period coincides with years in which they have a lot of other taxable income.

Note that the 10-year rule also applies to inherited Roth IRAs. However, there is an important difference. You still deplete the account in 10 years. However, the distributions are tax-free, provided the Roth was funded at least five years before the original owner died. If you do not need the money, waiting to take distributions until you are required to empty the account will give up to 10 years of tax-free growth.

Heirs who simply cash out their parents’ IRAs can take a lump sum from a traditional IRA. However, if you do, you will owe taxes on the entire amount, which could push you into a higher tax bracket.

Reference: Kiplinger (Oct. 28, 2021) “Minimizing Taxes When You Inherit Money”

 

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys

What Is the Best Thing to Do with an Inherited IRA? – Annapolis and Towson Estate Planning

When a parent dies and their adult child inherits a traditional IRA, knowing what to do can be the difference between an inheritance and a tax disaster. Many people take the money from the IRA account and place it into their own IRA. However, that is a mistake, says the article “How to manage an inherited IRA from a parent” from Sentinel Source.com.

Any inherited IRA, whether it is from a parent, sibling, or friend, cannot be simply rolled into your own account or treated as if it is your own IRA. Instead, the assets must be transferred in a timely manner to a new IRA that must be titled as an “Inherited IRA” that includes the name of the deceased owner and the phrase “For the benefit of…” and your name. Different financial institutions may have small variations in how they title the account. However, this seemingly small detail is critical.

If a traditional IRA has more than one beneficiary, it must be split into separate accounts for each beneficiary. Each heir will treat their own inherited portion in the same way, as if they were the sole beneficiary.

It is the heir’s choice to either set up a new Inherited IRA Beneficiary account with a financial institution or advisor of their own, or to create a new account using the prior institution. Sometimes using the same firm that held the account is easier, as long as the correct title is used.

The new owner of a Beneficiary IRA needs to know the rules to avoid costly penalties. After the SECURE Act became law in December 2019, most beneficiaries are now required to deplete an inherited IRA within ten (10) years of the original account owner’s death. This applies to any inherited IRAs where the owner has died after December 31, 2019.

The prior rules allowed Inherited IRAs to be depleted over the lifetime of the beneficiary, which allowed the accounts to grow tax-deferred and in many cases, be passed to a third generation, often referred to as “Stretch IRAs.” This option is gone.

There are no limits as to how much or how often withdrawals can be taken from the account, as long as it is depleted in ten years. However, the withdrawals are taxable as regular income, so if you wait until the ten year mark and take out the entire amount, you will end up with a hefty tax bill.

There are exceptions to the withdrawal rule. A surviving spouse, a minor child, a disabled or chronically ill beneficiary, or a beneficiary within ten years of age of the original IRA owner may have a little more time to withdraw funds (and pay taxes on the withdrawals).

If inheriting an IRA from a spouse, you may transfer the IRA balance into your own account and delay distributions until age 72.

Consider your IRAs carefully when working with an estate planning attorney on the distribution of your assets. Will your heirs be able to pay the taxes on their inherited IRAs, or should they be converted to Roth IRAs to relieve heirs of a future tax burden? These are questions that your estate planning attorney will be able to address.

Reference: Sentinel Source.com (Sep. 18, 2021) “How to manage an inherited IRA from a parent”

 

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys

Checklist for Estate Plan’s Success – Annapolis and Towson Estate Planning

We know why estate planning for your assets, family and legacy falls through the cracks.  It is not the thing a new parent wants to think about while cuddling a newborn, or a grandparent wants to think about as they prepare for a family get-together. However, this is an important thing to take care of, advises a recent article from Kiplinger titled “2021 Estate Planning Checkup: Is Your Estate Plan Up to Date?

Every four years, or every time a trigger event occurs—birth, death, marriage, divorce, relocation—the estate plan needs to be reviewed. Reviewing an estate plan is a relatively straightforward matter and neglecting it could lead to undoing strategic tax plans and unnecessary costs.

Moving to a new state? Estate laws are different from state to state, so what works in one state may not be considered valid in another. You will also want to update your address, and make sure that family and advisors know where your last will can be found in your new home.

Changes in the law. The last five years have seen an inordinate number of changes to laws that impact retirement accounts and taxes. One big example is the SECURE Act, which eliminated the Stretch IRA, requiring heirs to empty inherited IRA accounts in ten years, instead of over their lifetimes. A strategy that worked great a few years ago no longer works. However, there are other means of protecting your heirs and retirement accounts.

Do you have a Power of Attorney? A Power of Attorney (“POA”) gives a person you authorize the ability to manage your financial, business, personal and legal affairs, if you become incapacitated. If the POA is old, a bank or investment company may balk at allowing your representative to act on your behalf. If you have one, make sure it is up to date and the person you named is still the person you want. If you need to make a change, it is very important that you put it in writing and notify the proper parties.

Health Care Power of Attorney needs to be updated as well. Marriage does not automatically authorize your spouse to speak with doctors, obtain medical records or make medical decisions on your behalf. If you have strong opinions about what procedures you do and do not want, the Health Care POA can document your wishes.

Last Will and Testament is Essential. Your last will needs regular review throughout your lifetime. Has the person you named as an executor four years ago remained in your life, or moved to another state? A last will also names an executor for your property and a guardian for minor children. It also needs to have trust provisions to pay for your children’s upbringing and to protect their inheritance.

Speaking of Trusts. If your estate plan includes trusts, review trustee and successor appointments to be sure they are still appropriate. You should also check on estate and inheritance taxes to ensure that the estate will be able to cover these costs. If you have an irrevocable trust, confirm that the trustee is still ready and able to carry out the duties, including administration, management and tax returns.

Gifting in the Estate Plan. Laws concerning charitable giving also change, so be sure your gifting strategies are still appropriate for your estate. An estate plan review is also a good time to review the organizations you wish to support.

Reference: Kiplinger (July 28, 2021) “2021 Estate Planning Checkup: Is Your Estate Plan Up to Date?

 

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys

The Stretch IRA Is Diminished but Not Completely Gone – Annapolis and Towson Estate Planning

Before the SECURE Act, named beneficiaries who inherited an IRA were able to take distributions over the course of their lifetimes. This allowed the IRA to grow over many years, sometimes decades. This option came to an end in 2019 for most heirs, but not for all, says the recent article “Who is Still Eligible for a Stretch IRA?” from Fed Week.

A quick refresher: the SECURE Act—Setting Every Community Up for Retirement Enhancement—was passed in December 2019. Its purpose was, ostensibly, to make retirement savings more accessible for less-advantaged people. Among many other things, it extended the time workers could put savings into IRAs and when they needed to start taking Required Minimum Distributions (RMDs).

However, one of the features not welcomed by many, was the change in inherited IRA distributions. Those not eligible for the stretch option must empty the account, no matter its size, within ten years of the death of the original owner. Large IRAs are diminished by the taxes and some individuals are pushed into higher tax brackets as a result.

However, not everyone has lost the ability to use the stretch option, including anyone who inherited an IRA before January 1, 2020. This is who is included in this category:

  • Surviving Spouses.
  • Minor children of the deceased account owner–but only until they reach the age of majority. Once the minor becomes of legal age, he or she must deplete the IRA within ten years. The only exception is for full-time students, which ends at age 26.
  • Disabled individuals. There is a high bar to qualify. The person must meet the total disability definition, which is close to the definition used by Social Security. The person must be unable to engage in any type of employment because of a medically determined or mental impairment that would result in death or to be of chronic duration.
  • Chronically ill persons. This is another challenge for qualifying. The individual must meet the same standards used by insurance companies used to qualify policyowners for long-term care coverage. The person must be certified by a treating physician or other licensed health care practitioner as not able to perform at least two activities of daily living or require substantial supervision, due to a cognitive impairment.
  • Those who are not more than ten years younger than the deceased account owner. That means any beneficiary, not just someone who was related to the account owner.

What was behind this change? Despite the struggles of most Americans to put aside money for their retirement, which is a looming national crisis, there are trillions of dollars sitting in IRA accounts. Where better to find tax revenue, than in these accounts? Yes, this was a major tax grab for the federal coffers.

Reference: Fed Week (March 3, 2021) “Who is Still Eligible for a Stretch IRA?”

 

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys

What are the Taxes on My IRA Withdrawal? – Annapolis and Towson Estate Planning

Investopedia’s recent article entitled “How Much Are Taxes on an IRA Withdrawal?” explains that the withdrawal rules for other types of IRAs are similar to the traditional IRA, with some small unique differences. Other types of IRAs include the SEP IRA, Simple IRA and SARSEP IRA. However, each of these has different rules about who can open one.

Tax-Free Withdrawals Only with Roth IRAs. When you invest with a Roth IRA, you deposit the money post-tax. Therefore, when you withdraw the money in retirement, you pay no tax on the money you withdraw, or on any gains your investments earned. That is a big benefit. To do this, the money must have been deposited in the IRA and held for at least five years and you must be at least 59½ years old. If you need cash before that, you can withdraw your contributions with no tax penalty, provided you do not touch any of the investment gains. You should document any withdrawals before 59½ and tell the trustee to use only contributions, if you are withdrawing funds early. If you do not do this, you could be charged the same early withdrawal penalties charged for taking money out of a traditional IRA.

The Taxing of IRA Withdrawals. Money that is placed in a traditional IRA is treated differently from money in a Roth, because it is pretax income. Each dollar you deposit lessens your taxable income by that amount. When you withdraw the money, both the initial investment and the gains it earned are taxed at your income tax rate when withdrawn. However, if you withdraw money before you are 59½, you will be hit with a 10% penalty, in addition to regular income tax based on your tax bracket. If you accidentally withdraw investment earnings rather than only contributions from a Roth IRA before you are 59½, you can also incur a 10% penalty. You can, therefore, see how important it is to keep careful records.

Avoiding the Early Withdrawal Tax Penalty. There are a few hardship exceptions to the 10% penalty for withdrawing money from a traditional IRA or the investment-earnings portion of a Roth IRA before you reach age 59½.

Do not mix Roth IRA funds with the other types of IRAs. If you do, the Roth IRA funds will become taxable. Some states also levy early withdrawal penalties. Once you hit age 59½, you can withdraw money without a 10% penalty from any type of IRA. If it is a Roth IRA and you have had a Roth for five years or more, you will not owe any income tax. If it is not, you will have taxes due.

The funds put in a traditional IRA are treated differently from money in a Roth. If the money is deposited in a traditional IRA, SEP IRA, Simple IRA or SARSEP IRA, you will owe taxes at your current tax rate on the amount you withdraw. However, you will not owe any income tax, provided that you keep your money in a non-Roth IRA until you reach another key age milestone. Once you reach age 72 (with new SECURE Act), you will have to take a distribution from a traditional IRA. The IRS has specific rules about how much you must withdraw each year, which is called the required minimum distribution (RMD). If you do not withdraw your RMD, you could be hit with a 50% tax on the amount not distributed as required.

There are no RMD requirements for a Roth IRA, but if money is still there after your death, your beneficiaries may have to pay taxes. There are several different ways they can withdraw the funds, so they should get the advice of an attorney.

Reference:  Investopedia (Feb. 21, 2020) “How Much Are Taxes on an IRA Withdrawal?”

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys

What Should I Know about the Secure Act of 2019 and IRAs? – Annapolis and Towson Estate Planning

New federal rules for IRAs will significantly add to the tax burden for some heirs by telescoping the permitted period for withdrawals. But this pain can be greatly reduced by converting regular IRAs to Roth IRAs before bequeathing them, explains CNBC’s recent article entitled “Here is a way to beat the tax burden for IRA heirs.”

Before the new legislation, all heirs could enjoy their entire life expectancy to take withdrawals from inherited IRAs. As a result, they were able to stretch out these accounts, and the tax on withdrawals, over decades. That is why they were given the nickname “stretch IRAs.”

But this changed in December of 2019 when Congress passed the Secure Act of 2019. The bill preserves the lifelong stretch period for surviving spouses, minor children, the chronically ill, and other individuals who are not more than 10 years younger than their benefactors (this group would include most siblings). However, for other heirs—including adult children—the new rules restrict the stretch period to a single decade. Beginning with the IRA bequests from benefactors who die in 2020, heirs must now take out all of the funds from these accounts within 10 years and pay ordinary income tax on each withdrawal.

With this accumulated wealth to heirs, adult children will also be saddled with a huge tax burden. This means more of a need for estate planning to address this. Without estate-planning expertise, these beneficiaries will likely withdraw 10% of the IRA’s assets every year for 10 years to lessen the tax impact.

A wise solution for some is to convert their regular IRA into a Roth IRA. Unlike regular IRAs, contributions to Roth IRAs are made solely with post-tax money. Though unlike regular IRAs, Roth IRAs carry no income tax on withdrawals, the Secure Act means they will now be required to drain the account within 10 years of inheritance.

Note that as you get near retirement, converting to a Roth has a few other advantages. Holders of regular IRAs must begin taking annual required minimum distributions (RMDS) at age 72 (before the new legislation in December, this age was 70½).

However, if you plan to keep working or are retiring with sufficient income from other resources, you may not decide to take withdrawals. Rather, you may want to allow these assets in your account grow intact rather than gradually weaning them for withdrawal. Converting to a Roth allows you to do this.

Depending on your situation, a Roth conversion might be a wise option if—not only to lessen your heirs’ tax burden but also to sustain the growth of your retirement nest egg.

Ask your estate planning attorney about a Roth IRA conversion and how it fits into your estate plan.

Reference: CNBC (Feb. 12, 2020) “Here’s a way to beat the tax burden for IRA heirs”

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys

Alternatives for Stretch IRA Strategies – Annapolis and Towson Estate Planning

The majority of many people’s wealth is in their IRAs, that is saved from a lifetime of work. Their goal is to leave their IRAs to their children, says a recent article from Think Advisor titled “Three Replacements for Stretch IRAs.” The ability to distribute IRA wealth over years, and even decades, was eliminated with the passage of the SECURE Act.

The purpose of the law was to add an estimated $428 million to the federal budget over the next 10 years. Of the $16.2 billion in revenue provisions, some $15.7 billion is accounted for by eliminating the stretch IRA.

Existing beneficiaries of stretch IRAs will not be affected by the change in the law. But going forward, most IRA heirs—with a few exceptions, including spousal heirs—will have to take their withdrawals within a ten year period of time.

The estate planning legal and financial community is currently scrutinizing the law and looking for strategies that will protect these large accounts from taxes. Here are three estate planning approaches that are emerging as front runners.

Roth conversions. Traditional IRA owners who wished to leave their retirement assets to children may be passing on big tax burdens now that the stretch is gone, especially if beneficiaries themselves are high earners. An alternative is to convert regular IRAs to Roth IRAs and take the tax hit at the time of the conversion.

There is no guarantee that the Roth IRA will never be taxed, but tax rates right now are relatively low. If tax rates go up, it might make converting the Roth IRAs too expensive.

This needs to be balanced with state inheritance taxes. Converting to a Roth could reduce the size of the estate and thereby reduce tax exposure for the state as well.

Life insurance. This is being widely touted as the answer to the loss of the stretch, but like all other methods, it needs to be viewed as part of the entire estate plan. Using distributions from an IRA to pay for a life insurance policy is not a new strategy.

Charitable Remainder Trusts (CRT). The IRA could be used to fund a charitable remainder trust. This allows the benefactor to establish an income stream for heirs with part of the IRA assets, with the remainder going to a named charity. The trust can grow assets tax free. There are two different ways to do this: a charitable remainder annuity trust, which distributes a fixed annual annuity and does not allow continued contributions, or a charitable remainder unitrust, which distributes a fixed percentage of the initial assets and does allow continued contributions.

Speak with your estate planning lawyer about what options may work best in your unique situation.

Reference: Think Advisor (Jan. 24, 2020) “Three Replacements for Stretch IRAs”

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys