New Rules in Estate Planning

Although we mark Older Americans Month this month, oldsters would be well advised to consider the Younger Americans in their estate planning.

The Secure Act (learn more here) changed the rules for non-spousal inherited retirement accounts – and in the process may change the way bestow benefits on your children and grandchildren as part of their estate plan.

Prior to passage of the Secure Act, beneficiaries of a non-spousal inherited retirement account could stretch out distributions from that account based on their own life expectancy. Now, non-spouse beneficiaries have 10 years to take the distributions after the original owner’s death.

“It could be 10% a year it could be 100% in year five, but but it has to be within 10 years after you inherited the account,” says Beau Henderson, lead retirement planning specialist at RichLife Advisors in Gainesville, Georgia.

The RMD impact

…in some cases it creates taxation on money they may not need. 

 “What that’s done is that’s created a lot of unintentional tax complications for the beneficiary,” Henderson says. “And for the beneficiary, in some cases it creates taxation on money they may not need.  Some people are leaving substantial 401k(s) and IRAs. So, you can imagine if someone leaves a million-dollar IRA, and the beneficiary has to take that out over 10 years. That money that you have to take out at some point will be substantial, whether it’s $100,000 a year (over 10 years), $500,000 over two years.”

Eric Bond at Bond Wealth Management in Long Beach, California, says he has been advising his clients to take the distributions annually, and not wait to take a lump sum.

“We use the life expectancy table as a marker,” he says. “Let’s look at the last 10 years. Accounts have doubled. What you don’t want is, for example, your mom passed away and left $100,000 and it doubles 10 years later. Now you have a tax burden of twice as much. If you’re still working, that’s going to be really bad, because this is taxed at ordinary income rates.

“So, what I always say is, every year you should take some money out,” he says.

“Now, there can be an argument though, if someone’s going to be retiring in four or five years, and you’re making a large income now.  That might be a reason why to wait,” Bond says, “because you’ll not be making as much.”

Watch out for tax bracket creep

One of the biggest dangers for the non-spouse beneficiary is that the distribution added to their normal income pushes them into a higher tax bracket.

“We want to navigate the tax brackets as much as possible,” says Henderson. “Let’s say somebody inherits a million dollars. Pay attention to what tax bracket you’re in and how much room you have until you’re in that tax bracket. If somebody’s in a 22% tax bracket, and they’ve got another $60,000 in that tax bracket — what we don’t want to do is unnecessarily drive up to two to three tax brackets. If someone is left an inheritance and we just cash out the whole thing, they’re going to probably be taxed at 37%. Whereas if over that 10-year period, we pay attention to their income and their tax brackets, we can get the overall tax average down over by paying attention to how much we drew and what year. Somebody might have lower income one of those years and may be able to pull more out.”

Henderson says any beneficiary should have a distribution strategy and annual meetings with their advisors to make sure that they’re not caught in the trap of paying unnecessary taxes.

Is a Roth conversion the answer?

“That’s even more reason why people should work on Roth IRA conversions while they’re alive,” says Henderson. “It can reduce the tax we pay on Social Security. A conversion protects those pretax assets from being subjected to RMDs (required minimum distributions). It protects the client or the individual from future tax increases, but it also protects their beneficiaries.

“One way we can have our legacy live on even further is to do some of the work on the front end doing those conversions”

“One way we can have our legacy live on even further is to do some of the work on the front end doing those conversions,” he says. “You’re in a better position if you need it, and your beneficiaries are in a better position if they inherited. It’s kind of a win-win in that case.”

“The benefit to a Roth is you have no relationship with the government,” Bond says. “It doesn’t matter what the government does. They’re raising taxes. It doesn’t matter because it’s tax free. If you’re going to convert it, do it after you talk to a tax preparer, and they’ve seen how much (you immediate tax liability) is.”

Rodney A. Brooks is the former deputy managing editor/Money at USA TODAY. His retirement columns appear in U.S. News & World Report and Senior Planet.com. He has written for National Geographic, The Washington Post and USA TODAY. The author of “Fixing the Racial Wealth Gap,” Brooks has testified before the U.S. Senate Special Committee on Aging. His website is www.rodneyabrooks.com.

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