Some year-end financial considerations
As the year closes, we all will be glad to look forward. One way is to review retirement assets, consider The SECURE Act of 2019 and search for tax savings in 2021.
With the passage of the SECURE Act at the end of 2019, the Stretch IRA technique for non-spouse IRA beneficiaries ended. Now when most nonspouse beneficiaries inherit a retirement account, they can no longer take distributions over their lifetime from 401(k) s, IRAs, 403(b)s and 457 plans. Here are factors you should know:
• When most non-spouse beneficiaries (over 18) inherit a retirement account, they must liquidate the account within a 10year period.
• By the 10th anniversary of the original retirement account owner’s death, the inherited IRA account balance must be reduced to $0.
• During the 10-year period after the retirement account owner’s passing, the beneficiary who inherited the account is free to take distributions in any amount.
• Trust planning regarding the inheritance of retirement assets written into a will or included in a trust for a beneficiary should be revisited and may have to be re-written.
Additionally, there are Federal Tax implications based on current laws:
• Because pre-tax retirement account distributions are taxable in the year a distribution is taken at the individual’s personal income tax rate, this new law has significant tax implications for a beneficiary who inherits pre-tax retirement assets, when a distribution is made. The more rapid liquidation timeline, plus distributions, could elevate the beneficiary into a higher tax bracket.
• Pre-tax retirement assets typically include Traditional IRAs, pre-tax 401(k)s, pre-tax 403(b)s and pre-tax 457 plans.
• An IRA account owner who passes on a pre-tax retirement account with a large balance results in the beneficiary having less flexibility on taking distributions, and these distributions will likely be taxed at a higher rate than the Stretch IRA provision.
For example, based on current income tax rates, a beneficiary inherits a pre-tax retirement account with a $2,000,000 balance:
• If a married or single tax filing beneficiary waits 10 years before taking a distribution of an IRA with a $2,000,000-plus, and they take a full distribution for the entire account balance in the 10th year, they will be taxed at the 37% rate on income over ~$510k for Single tax filers, and ~$612k for Joint tax filers.
• If the beneficiary chooses to take a $200k distribution each year over 10 years, and the account balance does not grow, a single tax filer whose income is ~$204k or more will be taxed at the 35% marginal rate or higher for income above this level, while a married tax filer will be taxed at the 24% marginal rate or higher.
It’s important to look at Federal Estate and Gift Taxes:
• The current Federal Unified Estate and Gift Tax Exemption is $11,580,000 for a single individual. For a married individual who elects portability, the exemption is $23,160,000.
• There is no inheritance tax at the Federal level.
• Estate tax law and exemptions change frequently. Often laws in place depend on which party is in office.
There are also state-specific tax implications. Pennsylvania residents should be aware of these tax aspects:
• If a Pennsylvania resident dies there is no estate tax, but there is an inheritance tax.
• The resident’s child, grandchild, parent or other lineal heir will have their inheritance taxed at a rate of 4.5%.
• If the heir is a sibling, the inheritance will be taxed at 12%.
• All other heirs will be taxed at 15%, except charitable organizations and exempt institutions and government entities.
• There is no inheritance tax on gifts to a spouse or charity.
• Distributions from an inherited IRA are exempt from Pennsylvania state income tax.
There are strategies to mitigate taxes for beneficiaries and heirs, including life insurance and Roth IRA Conversions.
• Life insurance proceeds can be used by heirs or beneficiaries to help mitigate all or a portion of the amount they may lose to taxes.
• If the life insurance policy is owned by a properly structured
Irrevocable Life Insurance Trust and premiums are paid for by the ILIT, the proceeds could be excluded from the taxable estate.
• If an individual has excess cash flow, they can use it as a gift to an ILIT to pay premiums for a life insurance policy. The gift money can come from wages, interest income, dividend income, capital gains and other sources.
• If the gift to the ILIT is less than $15k-yr per beneficiary of the ILIT, it will not decrease an individual’s Federal Unified Estate and Gift Tax Exemption.
• Gifts to the ILIT in excess of $15k-yr per beneficiary will reduce the Federal Unified Estate and Gift tax exemption. The beneficiary must file a gift tax return.
• If total gifts to the ILIT and total estate do not exceed the Federal Estate and Gift Tax Exemption,
there will be no estate or gift tax levied.
With the proper structure in place, you can successfully convert your IRAs that may be subject to various taxes into a life insurance distribution that will be completely tax free.
• Converting pre-tax retirement account assets to a Roth IRA is another way to ease the tax impact of the beneficiary inheriting a pre-tax retirement account. By converting pre-tax assets to Roth assets, the account owner can pay taxes now, and their beneficiaries can avoid paying taxes on the Roth assets when they make their withdrawals, after the account owner dies.
• This does not avoid the 10year liquidation rule for the account, but distributions from an inherited Roth IRA will not be subject to Federal or State income taxes.
• The Roth assets can grow tax deferred up to 10-years. This can help maximize the asset value before the beneficiary has to liquidate the account.
Have a wonderful holiday, and enjoy exploring assets and tax saving for future beneficiaries.
An IRA account owner who passes on a pretax retirement account with a large balance results in the beneficiary having less flexibility on taking distributions, and these distributions will likely be taxed at a higher rate than the Stretch IRA provision.
Pete Hoover was destined to be a financial advisor. He has always been intrigued by numbers and money matters. They represent captivating puzzles to be analyzed, shaped and fit into place as pictures of financial solidarity. For nearly 40 years, Hoover has tackled those financial puzzles. In 2005, he launched Hoover Financial Advisors, located in Malvern. Hoover can be reached by emailing pete@hfaplanning.