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SECURE Act is a game-changer for estate planning

Published on: 
Medical Economics Journal, Medical Economics October 2022 edition, Volume 99, Issue 10

As a result of changes from the SECURE Act, for the tax benefit of the entire family, parents with highly appreciated retirement accounts may want to re-think bequests.

Many parents, seeking to be completely fair, bequeath assets in equal amounts to each of their children. For sibling heirs who inherit their parents’ estates collectively, this usually means liquidating assets to settle the estate.

Relatively new tax rules on inherited tax-deferred retirement accounts—IRAs and 401(k)s—complicate this kind of estate planning considerably, especially for physicians with high net worth bequeathing large, highly appreciated accounts. The new rules are forcing even the most doting of parents to reconsider what’s fair.

These rules are part of the SECURE Act of 2019, a sweeping package of legislation with ramifications that are taking time to sink in regarding estate planning. Under previous rules, heirs receiving tax-deferred retirement accounts had their entire lives to draw them down completely, as required by the IRS; that’s why these accounts acquired the moniker, “stretch” IRAs. By stretching out these distributions, heirs could minimize the tax impact in any one year and avoid bracket creep.

The SECURE Act changed all this by requiring heirs to draw down these accounts down within 10 years of the benefactor’s death in most cases, but there are exceptions for certain categories of beneficiaries. (For more information, see IRS Publication 590-B, “Distributions from Individual Retirement Arrangements,” available on www.irs.gov).

Depending on the size of the retirement account, the income of the recipient and their tax scenario, inheriting the account may result not only in higher income tax in any one year, but also higher rates of taxation from bracket creep, or even what could be called bracket zoom—going up multiple brackets.

As a result, for the tax benefit of the entire family, parents with highly appreciated retirement accounts may want to re-think bequests. Here are some considerations regarding strategies for minimizing tax impacts:

The practice of leaving everything to the children for them to divide may now be less than optimal. Regarding large accounts, the 10-year distribution limit might mean that even part of one could bring a huge tax burden to one or more heirs. A preferable alternative might be for such heirs to instead receive other items, such as real estate. The stepped-up basis of real property might have far less impactful tax consequences.

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Consider leaving taxable accounts, such as IRAs, to children who are doing less well than their siblings, and then evening out the dollar-value of bequests using other assets. If you have three children and one has a relatively low income, that child might be the best candidate for receiving the entire retirement account. The other two could receive more tax-friendly assets.

One solution might be to leave all the children a Roth IRA collectively. Like regular IRAs and 401(k) accounts, Roths also must be distributed within 10 years. But, as these accounts are funded with post-tax money, withdrawals don’t incur tax or add to taxable incomes. As converting tax-deferred accounts into Roths involves paying the tax due on these distributions, conversions can involve considerable expense. Whether this is a good option depends on how the numbers work out for benefactors and heirs.

For wealthy benefactors, Roth conversions are usually a partial solution at best. IRS rules prohibit Roth contributions from individuals with annual earned incomes of $144,000 and up and, for married couples filing jointly, of $214,000 and up. So it’s difficult for high earners to accumulate a substantial portion of their wealth in a Roth. Though some high earners may have started Roth IRAs when they were earning far less, and these accounts may have appreciated substantially over the years, they aren’t likely to hold much in the way of total assets, proportionately, of wealthy individuals.

Converting a regular IRA to a Roth might be a solution. Though the income limits for contributions also apply to conversions, this strategy still might be feasible, depending on your circumstances and the timing involved. That’s because it’s all about the tax year of the conversion.

You might be able to convert in the tax year after retiring. Under this strategy, the idea is to limit income in the year of conversion, perhaps by delaying Social Security benefits (which must be claimed by age 70), and/or by delaying other retirement income streams (such as pensions) and withdrawals from taxable investment accounts.


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