Estate Planning Blog Articles

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Should I Withdraw more than RMD?

As most know, once a person hits 72, the IRS require you to take a certain minimum amount from your IRA each year. Many do take only the minimum, believing that this will leave more assets to grow tax deferred. However, recent tax changes are a reason to revisit one’s IRA distribution strategy.

MSN’s article entitled “Should You Take an Extra Big RMD This Year?” says that although some people are worried about paying more in taxes this year than they need to may want stay to the bare minimum of their required minimum distribution (RMD), others seek to find a broader tax strategy.

Those people may want to consider going big with their RMDs. Let’s look the wisdom of taking more than the required minimum distribution from your IRA.

The article gives us four considerations to help with your RMD decision about possibly taking more than the IRA RMD in any year:

  1. Your tax bracket. Determine the amount of additional income you can recognize this year, while still staying within your current tax bracket. Taxpayers in the 10% and 12% tax brackets should be especially cognizant of maximizing ordinary income in these relatively low tax brackets.
  2. Your income. See what your income’s projected to be next year and consider whether you (or you and your spouse) will have other sources of income in future years, such as an inherited IRA, spouse’s IRA RMD or annuity income to add to the mix.
  3. Your beneficiaries. Look at the way in which your current tax rate compares with the tax rates of your IRA beneficiaries. If you have a large IRA and children with high incomes of their own, your heirs could be pushed into a much higher tax bracket when they start their inherited IRA distributions.
  4. Your Medicare premiums. An increase in income can also result in higher Medicare Part B & D premiums in coming years. As a result, consider this in the context of total savings.

Reference: MSN (Nov. 23, 2021) “Should You Take an Extra Big RMD This Year?”

 

Can I Avoid Taxes when I Inherit?

Kiplinger’s recent article entitled “Minimizing Taxes When You Inherit Money” says that if you inherit an IRA from a parent, the taxes on mandatory withdrawals could mean you will have a smaller inheritance than you anticipated.

Prior to 2020, beneficiaries of inherited IRAs or other tax-deferred accounts, like 401(k)s, could transfer the money into an account known as an inherited (or “stretch”) IRA. From there, you could take withdrawals over your life expectancy, allowing you to minimize withdrawals taxed at ordinary income tax rates. This lets the funds in the account to grow.

However, the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 stopped this tax-saving strategy. Most adult children and other non-spouse heirs who inherit an IRA after January 1, 2020, now have two options: (i) take a lump sum; or (ii) transfer the money to an inherited IRA that must be depleted within 10 years after the death of the original owner. This 10-year rule doesn’t apply to surviving spouses, who can roll the money into their own IRA and allow the account to grow, tax-deferred, until they must take required minimum distributions (RMDs) at 72.  Spouses can also 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 for those who are minors, disabled, chronically ill, or less than 10 years younger than the original IRA owner.

As a result, IRA beneficiaries who aren’t eligible for the exceptions could wind up with a big tax bill, especially if the 10-year withdrawal period is when they have a lot of other taxable income.

The 10-year rule also applies to inherited Roth IRAs. However, although you must still deplete the account in 10 years, the distributions are tax-free, provided the Roth was funded at least five years before the original owner died. If you don’t need the money, delay in taking the distributions until you’re required to empty the account. That will give you up to 10 years of tax-free growth.

Many heirs cash out their parents’ IRAs. However, if you take a lump sum from a traditional IRA, you’ll owe taxes on the whole amount, which might move you into a higher tax bracket.

Transferring the money to an inherited IRA lets you allocate the tax bill, although it’s for a shorter period than the law previously allowed. Since the new rules don’t require annual distributions, there’s a bit of flexibility.

Reference: Kiplinger (Oct. 29, 2021) “Minimizing Taxes When You Inherit Money”

Am I Missing Retiree Tax Breaks?

Seniors frequently can miss tax-saving opportunities. In many cases, it’s simply because they just don’t know about them, says Kiplinger’s recent article entitled “The Most-Overlooked Tax Breaks for Retirees.” Let’s look at some these:

A Larger Standard Deduction. When you turn 65, the IRS offers you a bigger standard deduction. For 2020 returns, a single 64-year-old gets a standard deduction of $12,400 ($12,550 for 2021). A single 65-year-old gets $14,050 in 2020 ($14,250 in 2021). That $1,700 will make it more likely that you’ll take the standard deduction rather than itemizing. If you do, the additional amount will save you more than $400 if you’re in the 24% bracket. Couples in which one or both spouses are age 65+, also get larger standard deductions than younger taxpayers.

Medicare Premium Deduction. If you become self-employed when you leave your job, you can deduct the premiums you pay for Medicare Part B and Part D, plus the cost of supplemental Medicare (Medigap) policies or the cost of a Medicare Advantage plan. It isn’t subject to the 7.5%-of-AGI test that applies to itemized medical expenses. However, you can’t claim this deduction if you’re eligible to be covered under an employer-subsidized health plan offered by either your employer (if you have retiree medical coverage, for example) or your spouse’s employer (if he or she has a job that offers family medical coverage).

Spousal IRA Contribution. You must have earned income to contribute to an IRA, but if you’re married, and your spouse is still working, he or she can contribute up to $7,000 a year to an IRA that you own. Provided your spouse has enough earned income to fund the contribution to your account (and any deposits to his or her own), this is an option.

The RMD Workaround. Required minimum distributions (RMDs) weren’t required in 2020 (due to COVID), but retirees taking RMDs from their traditional IRAs in 2021 and beyond may have an extra option for meeting the pay-as-you-go demand. If you don’t need the RMD during the year, wait until December to take the money. You can ask your IRA sponsor to hold a large part of it for the IRS—enough to cover your estimated tax on both the RMD and your other taxable income as well. If your RMD is more than large enough to cover your tax bill, you can keep your cash safely in its tax shelter most of the year and still avoid the underpayment penalty.

Reference: Kiplinger (Dec. 29, 2020) “The Most-Overlooked Tax Breaks for Retirees”

sole beneficiary sharing

What If a Sole Beneficiary Wants to Share?

That doesn’t sound like a bad idea, right?

However, Morningstar’s recent article entitled “3 Strategies to Consider When Sole Beneficiaries Want to Share the Wealth” says that there are a few hurdles to clear, such as the IRA administrator’s policies, income tax consequences, transfer tax consequences and the terms of the decedent’s will.

Here’s a scenario: Uncle Buck dies and leaves his IRA to his niece, Hope. Buck’s will leaves all his other assets equally to all three of his nieces: sisters Hope, Faith and Charity. However, the three agree that Buck’s IRA should be shared equally, like the rest of the estate. What do they do?

The Easy Way. Hope keeps the IRA, withdraws from it when she wants (and as required by the minimum distribution rules), pays the income tax on her withdrawals and makes cash gifts to Faith and Charity (either now or as she withdraws from the IRA) in an agreed upon the amount. It would mean giving her two sisters ⅓ of the after-tax value of the IRA. There is no court proceeding or issue with the IRA provider. There are no income tax consequences because Hope will pay the other girls only the after-tax value of the IRA distributions she receives. However, there’s a transfer tax consequence: Hope’s transfers would be considered as gifts for gift tax purposes because she has no legal obligation to share the IRA with the other nieces. Any gift over the annual exclusion amount in any year ($15,000 as of 2020) will be using up some of Hope’s lifetime gift and estate tax exemption. This easy answer may work well for a not-too-large inherited IRA.

The Expensive Method: Reformation. If there is evidence that Buck made a mistake in filling out the beneficiary form, a court-ordered reformation of the document may be appropriate. Therefore, if Hope, Faith, and Charity have witnesses who would testify that the decedent told them shortly before he died, “I’m leaving all my assets equally to my three nieces,” it could be evidence that he made a mistake in completing the beneficiary designation form for the IRA. The court could order the IRA provider to pay the IRA to all three girls, and the IRS would probably accept the result. By accepting the result, the IRS would agree that the nieces should be equally responsible for their respective shares of income tax on the IRA and for taking the required distributions, and that no taxable gift occurred. However, as you might expect, the IRS isn’t legally bound by a lower state court’s order. If the reformation is based on evidence, the parties may want the tax results confirmed by an IRS private letter ruling, which is an expensive and time-consuming task.

The In-Between. The final possible solution is a qualified disclaimer. Hope would “disclaim” two thirds of the IRA (and keep a third). A qualified disclaimer (made within nine months after Buck’s death) would be effective to move two thirds of the IRA (and the income taxes) from Hope without gift taxes. A qualified disclaimer involves a legal fee but no court or IRS involvement. As a result, it can be fairly simple and cost-effective. However, there may be an issue: when Hope disclaims two thirds of the IRA, that doesn’t mean the disclaimed share of the IRA automatically goes to the other nieces. Instead, the disclaimed portion of the IRA will pass to the contingent beneficiary of the IRA. Hope needs to see where it goes next, prior to signing the disclaimer. If there’s no contingent beneficiary named by Buck, the disclaimed portion will pass to the default beneficiary named in the IRA provider’s plan documents. That’s typically the decedent’s probate estate. If the disclaimed portion of the IRA passes to the uncle’s estate, and Hope is a one-third beneficiary of the estate, she will also need to disclaim her estate-derived share of the IRA. A “simple disclaimer” can be complicated, so ask an experienced estate planning attorney to help.

Even if Hope disclaims two thirds of the IRA, so that it passes to Faith and Charity through the estate, the other girls won’t receive as favorable income tax treatment as Hope. Hope inherits her share as designated beneficiary, while an estate (the assumed default beneficiary), which isn’t a designated beneficiary, can’t qualify for that.

Reference: Morningstar (Aug. 13, 2020) “3 Strategies to Consider When Sole Beneficiaries Want to Share the Wealth”

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