Which Is Better a Traditional IRA or a Roth?

FedWeek’s recent article entitled “Does a Roth IRA, or Roth Conversion Make Sense for You?” explains that with a traditional IRA, if your income is below certain levels, you make pre-tax contributions to your IRA (that you may be able to deduct) and pay your taxes when you withdraw that money after retirement, when you may be in a lower tax bracket. You’re paying those taxes on both your contributions and the earnings on those contributions. In contrast, with a Roth IRA, you contribute already taxed money to the IRA and, if your withdrawals are qualified, you pay no taxes at the time of withdrawal.

If you started your retirement savings before the introduction of the Roth or if you have had incomes too high to allow you to contribute to a Roth, you may want to move more of your retirement savings from traditional IRAs (where you pay taxes at withdrawal) to Roth IRAs (where you pay taxes up front, but benefit from tax free growth).

A Roth IRA conversion allows you to move monies from your traditional IRA into a new or existing Roth IRA. There are no income limits or limits on the amount that can be converted, but you must pay tax on all untaxed monies that you convert. Therefore, if you converted money from a traditional IRA where you were able to deduct your contributions, you’d pay tax on every dollar you converted. And if you converted money from a traditional IRA where you were not able to deduct your contributions, you’d pay tax on the amount of the conversion that was attributable to earnings. These taxes would be at your rate for ordinary income. Think about these items, before you decide to convert money from a traditional IRA to a Roth IRA:

When will you need the money? If you have an immediate need for the funds or need them to support your current standard of living, then a Roth conversion is probably not a good idea. But if you have no immediate need for the funds, a Roth conversion can be a terrific way for your money to grow tax-free over your lifetime.

Where will the money come from to pay the tax? Typically, the money to pay the tax on the Roth conversion should come from outside funds and not from a retirement account, if the conversion is to make sense. When a conversion is made, it almost always triggers a taxable event. As a result, your ability to pay that tax with outside money will go a long way in determining if a Roth conversion is right for you.

What do you think future tax rates will be? If you think that your income tax rate will be the same or higher in retirement, then converting funds to a Roth is wise. That’s because you’ll be paying your taxes at a lower rate. But if you believe your income tax rate will be lower in retirement, conversion may not be right for you.

Reference: FedWeek (March 30, 2021) “Does a Roth IRA, or Roth Conversion Make Sense for You?”

Are Roth IRAs Smart for Estate Planning?

Think Advisor’s recent article entitled “Secure Act 2.0, Biden Tax Hike Plans Make Roth IRAs a Crucial Tool” says that Roth IRAs offer an great planning tool, and that the Secure Act 2.0 retirement bill (which is expected to pass) will create an even wider window for Roth IRA planning.

With President Biden’s proposed tax increases, it is wise to leverage Roth conversions and other strategies while tax rates are historically low—and the original Secure Act of 2019 made Roth IRAs particularly valuable for estate planning.

Roth Conversions and Low Tax Rates. Though tax rates for some individuals may increase under the Biden tax proposals, rates for 2021 are currently at historically low levels under the Tax Cuts and Jobs Act passed at the end of 2017. This makes Roth IRA conversions attractive. You will pay less in taxes on the conversion of the same amount than you would have prior to the 2017 tax overhaul. It can be smart to make a conversion in an amount that will let you “fill up” your current federal tax bracket.

Reduce Future RMDs. The money in a Roth IRA is not subject to RMDs. Money contributed to a Roth IRA directly and money contributed to a Roth 401(k) and later rolled over to a Roth IRA can be allowed to grow beyond age 72 (when RMDs are currently required to start). For those who do not need the money and who prefer not to pay the taxes on RMDs, Roth IRAs have this flexibility. No RMD requirement also lets the Roth account to continue to grow tax-free, so this money can be passed on to a spouse or other beneficiaries at your death.

The Securing a Strong Retirement Act, known as the Secure Act 2.0, would gradually raise the age for RMDs to start to 75 by 2032. The first step would be effective January 1, 2022, moving the starting age to 73. If passed, this provision would provide extra time for Roth conversions and Roth contributions to help retirees permanently avoid RMDs.

Tax Diversification. Roth IRAs provide tax diversification. For those with a significant amount of their retirement assets in traditional IRA and 401(k) accounts, this can be an important planning tool as you approach retirement. The ability to withdraw funds on a tax-free basis from your Roth IRA can help provide tax planning options in the face of an uncertain future regarding tax rates.

Estate Planning and the Secure Act. Roth IRAs have long been a super estate planning vehicle because there is no RMD requirement. This lets the Roth assets continue to grow tax-free for the account holder’s beneficiaries. Moreover, this tax-free status has taken on another dimension with the inherited IRA rules under the Setting Every Community Up for Retirement Enhancement (Secure) Act. The legislation eliminates the stretch IRA for inherited IRAs for most non-spousal beneficiaries. As a result, these beneficiaries have to withdraw the entire amount in an inherited IRA within 10 years of inheriting the account. Inherited Roth IRAs are also subject to the 10-year rule, but the withdrawals can be made tax-free by account beneficiaries, if the original account owner had met the 5-year rule prior to his or her death. This makes a Roth IRA an ideal estate planning tool in situations where your beneficiaries are non-spouses who do not qualify as eligible designated beneficiaries.

Reference: Think Advisor (May 11, 2021) “Secure Act 2.0, Biden Tax Hike Plans Make Roth IRAs a Crucial Tool”

What are Top ‘To-Dos’ in Estate Planning?

Spotlight News’ recent article entitled “Estate Planning To-Dos” says that with the potential for substantial changes to estate and gift tax rules under the Biden administration, this may be an opportune time to create or review our estate plan. If you are not sure where to begin, look at these to-dos for an estate plan.

See an experienced estate planning attorney to discuss your plans. The biggest estate planning mistake is having no plan whatsoever. The top triggers for estate planning conversations can be life-altering events, such as a car accident or health crisis. If you already have a plan in place, visit your estate planning attorney and keep it up to date with the changes in your life.

Draft financial and healthcare powers of attorney. Estate plans contain multiple pieces that may overlap, including long-term care plans and powers of attorney. These say who has decision-making power in the event of a medical emergency.

Draft a healthcare directive. Living wills and other advance directives are written to provide legal instructions describing your preferences for medical care, if you are unable to make decisions for yourself. Advance care planning is a process that includes quality of life decisions and palliative and hospice care.

Make a will. A will is one of the foundational aspects of estate planning, However, this is frequently the only thing people do when estate planning. A huge misconception about estate planning is that a will can oversee the distribution of all assets. A will is a necessity, but you should think about estate plans holistically—as more than just a will. For example, a modern aspect of financial planning that can be overlooked in wills and estate plans is digital assets.  It is also recommended that you ask an experienced estate planning attorney about whether a trust fits into your circumstances, and to help you with the other parts of a complete estate plan.

Review beneficiary designations. Retirement plans, life insurance, pensions and annuities are independent of the will and require beneficiary designations. One of the biggest estate planning mistakes is having outdated beneficiary designations, which only supports the need to review estate plans and designated beneficiaries with an experienced estate planning attorney on a regular basis.

Reference: Spotlight News (May 19, 2021) “Estate Planning To-Dos”

Stretch Out IRA Distributions, Even Without ‘Stretch’ IRA

It’s sad but true: the SECURE Act took away the long lifetime stretch that so many IRA heirs enjoyed. It was a great efficiency tool for family wealth transfer, but there are ways to fill the gap. A recent article “3 Strategies That Dry Your Stretch IRA Tears” from InsuranceNewsNet.com explains what to do now that IRAs need to be cashed out within ten years of the original owner’s death.

There are a number of tax-efficient planning opportunities, falling into three basic categories: wealth replacement with life insurance, Roth planning and charitable opportunities.

The life insurance policy is straightforward: parents buy life insurance to close the gap between what the IRA could have been, if it had been stretched out over the heir’s lifetime. For parents who are in a lower tax bracket than their children, it might make sense for parents to take distributions out of their IRA and buy insurance with after-tax dollars. This method may also present an opportunity for parents to purchase life insurance with long-term care protection, if they have not already done so.

The “Slow Roth” strategy is for families who might not think they can benefit from a Roth, but they can—just not all at once. By converting an IRA to a Roth IRA over time, only in amounts that keep parents in the same tax bracket, and paying taxes on the conversion slowly and over time, the Roth IRA can be built up so when it is inherited, even though it has to be taken out within ten years after your death, it is income tax free.

The third strategy is for families already planning on making charitable gifts. A Qualified Charitable Distribution, or QDC, lets the owner make distributions directly from their IRA to qualified charities, up to $100,000 annually. Remember that the distribution must go directly to the charity and it cannot be used for a donation to a donor-advised fund or private foundation. Your estate planning attorney will be able to help determine if your charity of choice qualifies.

Finally, you can name a Charitable Remainder Trust as an IRA Beneficiary. This is not a do-it-yourself project and mistakes can be costly. By naming a CRT as a beneficiary of your IRA, you avoid taxes on the entire lump sum when the trust liquidates the IRA. At the same time, the income beneficiary of the trust can receive income from the CRT over their lifetime or a term that you determine. It can’t be more than twenty years from the date of death, but twenty years is a long time. The payments from the trust will be treated as taxable income, so be sure that this will work for the recipient. If you accidentally push them into a higher tax bracket, they may not be quite as grateful as you wanted.

Reference: InsuranceNewsNet.com (Oct. 28, 2020) “3 Strategies That Dry Your Stretch IRA Tears”

Protect Your Estate with Five Facts

It is true that a single person who dies in 2020 could have up to $11.58 million in personal assets and their heirs would not have to pay any federal estate tax. However, that doesn’t mean that regular people don’t need to worry about estate taxes—their heirs might have to pay state estate taxes, inheritance taxes or the estate may shrink because of other tax issues. That’s why U.S. News & World Report’s recent article “5 Estate Planning Tips to Keep Your Money in the Family” is worth reading.

Without proper planning, any number of factors could take a bite out of your children’s inheritance. They may be responsible for paying federal income taxes on retirement accounts, for instance. You want to be sure that a lifetime of hard work and savings doesn’t end up going to the wrong people.

The best way to protect your family and your legacy, is by meeting with an estate planning attorney and sorting through all of the complex issues of estate planning. Here are five areas you definitely need to address:

  1. Creating a last will and testament
  2. Checking that beneficiaries are correct
  3. Creating a trust
  4. Converting traditional IRA accounts to Roth accounts
  5. Giving assets while you are living

A last will and testament. Only 32% of Americans have a will, according to a survey that asked 2,400 Americans that question. Of those who don’t have a will, 30% says they don’t think they have enough assets to warrant having a will. However, not having a will means that your entire estate goes through probate, which could become very expensive for your heirs. Having no will also makes it more likely that your family will challenge the distribution of assets. As a result, someone you may have never met could inherit your money and your home. It happens more often than you can imagine.

Checking beneficiaries. Once you die, beneficiaries cannot be changed. That could mean an ex-spouse gets the proceeds of your life insurance policy, retirement funds or any other account that has a named beneficiary. Over time, relationships change—make sure to check the beneficiaries named on any of your documents to ensure that your wishes are fulfilled. Your will does not control this distribution and is superseded by the named beneficiaries.

Set up a trust. Trusts are used to accomplish different goals. If a child is unable to manage money, for instance, a trust can be created, a trustee named and the account funded. The trust will include specific directions as to when the child receives funds or if any benchmarks need to be met, like completing college or staying sober. With an irrevocable trust, the money is taken out of your estate and cannot be subject to estate taxes. Money in a trust does not pass through probate, which is another benefit.

Convert traditional IRAs to Roth retirement accounts. When children inherit traditional IRAs, they come with many restrictions and heirs get the income tax liability of the IRA. Regular income tax must be paid on all distributions, and the account has to be emptied within ten years of the owner’s death, with limited exceptions. If the account balance is large, it could be consumed by taxes. By gradually converting traditional retirement accounts to Roth accounts, you pay the taxes as the accounts are converted. You want to do this in a controlled fashion, so as not to burden yourself. However, this means your heirs receive the accounts tax-free.

Gift with warm hands, wisely. Perhaps the best way to ensure that money stays in the family, is to give it to heirs while you are living. As of 2020, you may gift up to $15,000 per person, per year in gifts. The money is tax free for recipients. Just be careful when gifting assets that appreciate in value, like stocks or a house. When appreciating assets are inherited, the heirs receive a step-up in basis, meaning that the taxable amount of the assets are adjusted upon death, so some assets should only be passed down after you pass.

Reference: U.S. News & World Report (Sep. 30, 2020) “5 Estate Planning Tips to Keep Your Money in the Family”

Alternatives for Stretch IRA Strategies

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 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”

Some Estate Planning Actions for 2020

Many of us set New Year’s resolutions to improve our quality of life. While it’s often a goal to exercise more or eat more healthily, you can also resolve to improve your financial well-being. It’s a great time to review your estate plan to make sure your legacy is protected.

The Tennessean’s recent article entitled “Five estate-planning steps to take in the new year” gives us some common updates for your estate planning.

Schedule a meeting with your estate planning attorney to discuss your situation and to help the attorney create your estate plan.

You should also regularly review and update all your estate planning documents.

Goals and priorities change, so review your estate documents annually to make certain that your plan continues to reflect your present circumstances and intent. You may have changes to family or friendship dynamics or a change in assets that may impact your estate plan. It could be a divorce or remarriage; a family member or a loved one with a disability diagnosis, mental illness, or addiction; a move to a new state; or a change in a family business. If there’s a change in your circumstances, get in touch with your estate planning attorney to update your documents as soon as possible.

Federal and state tax and estate laws change, so ask your attorney to look at your estate planning documents every few years in light of any new legislation.

Review retirement, investment, and trust accounts to make certain that they achieve your long-term financial goals.

A frequent estate planning error is forgetting to update the beneficiary designations on your retirement and investment accounts. Thoroughly review your accounts every year to ensure everything is up to snuff in your estate plan.

Communicate your intent to your heirs, who may include family, friends, and charities. It is important to engage in a frank discussion with your heirs about your legacy and estate plan. Because this can be an emotional conversation, begin with the basics.

Having this type of conversation now, can prevent conflict and hard feelings later.

Reference: Tennessean (Jan. 3, 2020) “Five estate-planning steps to take in the new year”

How Can Life Insurance Help My Estate Plan?

In the 1990s, it wasn’t unusual for people to buy second-to-die life insurance policies to help pay federal estate taxes. However, in 2019, with estate tax exclusions up to $11,400,000 (and rising with the cost-of-living adjustments), fewer people would owe much for estate taxes.

However, IRAs, 401(k)s, and other accounts are still 100% taxable to the individuals, spouses and their children. The stretch IRA options still exist, but they may go away, as Congress may limit stretch IRAs to a maximum of 10 years.

Forbes’ recent article, “3 Ways Life Insurance Can Help Your Estate Plan,” explains that as the IRA is giving income from the RMDs, it may also be added, after tax, to the life insurance policy. If this occurs, it’s even possible that the death benefits could grow in the future, giving a cost-of-living benefit to children. This is one way how life insurance can be used creatively to help your estate plan.

For married couples, one strategy is to consider how life insurance on one individual could be used to pay “conversion tax” at death, using tax-free benefits. When the retiree dies, the spouse beneficiary can then convert all the IRA (taxable money) to a Roth IRA, which is tax-exempt with new, lower income tax rates (37% in 2018-2025 versus 39.6% in 2017 or earlier).

This tax-free death benefit money can be used to pay the taxes on the conversion, letting the surviving beneficiary have a lifetime of tax-exempt income without RMD issues from the Roth IRA. The Social Security income could also be tax-exempt, because Roth withdrawals don’t count as “income” in the calculation to see how much of your Social Security is taxed. However, you’d have to be within the threshold for any other combined income.

Life insurance for both individuals (if married) may also be a good idea. If the spouse of the IRA owner dies, the money from the life insurance can be used once again. If this is done in the tax year of the death for married individuals, the tax conversion could be done under “married filing status” before the next year, when the individual must use single tax filing status.

Another benefit of the IRA-to-Roth conversion is the passing of Roth IRAs to heirs, which could create a lasting legacy, if planned well. New life insurance policies that add long-term care features with chronic care and critical care benefits can also provide an extra degree of benefits, if one of the insureds has health issues prior to death.

Be sure to watch the tax rates and possible changes. With today’s lower tax rates, this could be very beneficial. Remember that there are usually individual state taxes as well. However, considering all the tax-optimized benefits to spouses and beneficiaries, the long-term tax benefits outweigh the lifetime tax liabilities, especially when you also consider SSI tax benefits for the surviving spouse and no RMD issues.

Life insurance in retirement can help protect, build and transfer wealth in one of the easiest ways possible. If you’re not certain about where to start with your life insurance needs, speak with an experienced estate planning attorney.

Reference: Forbes (November 15, 2019) “3 Ways Life Insurance Can Help Your Estate Plan”

What Can I Do with an Inherited 401(k)?

Inheriting a 401(k) at the death of the account owner isn’t always as simple as inheriting a home or a piece of jewelry. The IRS has rules that 401(k) beneficiaries must follow that say when and how much tax they’ll pay to inherit someone else’s retirement plan. If you’re currently the beneficiary of a 401(k) or you’ve recently inherited one, here are some important things you need to know.

Smart Assets’s recent article entitled “A Guide to Inheriting a 401(k)” explains that if a spouse of the account owner waives their right to inherit a 401(k) or the account owner is unmarried, they can leave their account to whomever they want at their death.

An inherited 401(k) is taxed is based on three key factors: (i) your relationship to the account owner; (ii) your age when you inherit the 401(k); and (iii) the account owner’s age when they die.

There’s also several ways to take a distribution from a 401(k) when you’ve inherited it: you can do a lump sum, periodic payments, or distributions stretched out over your life expectancy.

If you inherit a 401(k) from your spouse, what you decide to do with it and the subsequent tax impacts may be based primarily upon your age. If you’re under age 59½, you have a choice of three things:

  1. Keep the money in the plan and take distributions. You can take withdrawals from the account without the 10% early withdrawal penalty. You’d still pay regular income tax on any distributions you take. If your spouse was age 70½ or older when they passed away, you would have to take required minimum distributions from this account. There’d be no early withdrawal penalty. However, you’d pay income tax on the withdrawals. If the spouse was younger than 70½ when they died, you could wait to take RMDs until you turn 70½.
  2. Move the money to an inherited IRA. This is an IRA that’s designed to hold rollover funds from an inherited retirement plan, including 401(k)s. You can make withdrawals without any early withdrawal penalty. With this type of account, you’d need to take RMDs. However, the amount would be based on your own life expectancy, not the amount your spouse would have been required to take.
  3. Move the money to your own IRA. If you already have an IRA, you could roll an inherited 401(k) into it with no tax penalty. However, if you’re under age 59½ when you execute the rollover, the withdrawal will be treated like a regular distribution, so you’ll pay income tax on the full amount, along with the 10% early withdrawal penalty. If you’re over age 59½, you won’t pay an early withdrawal penalty with any of these options. If your spouse was taking RMDs from their 401(k) when they died, you’d have the option to continue taking them or delay taking them until you turn 70½. If you’re already 70½ or older, you’d need to take RMDs, regardless of whether you leave the money in the 401(k), transfer it to an inherited IRA or roll it over to your existing IRA.

If you inherit a 401(k) from someone other than your spouse, your options are linked to how old the account owner was when you inherited the plan and the plan’s distribution rules. If the account owner hadn’t yet turned 70½, the plan may let you spread distributions out over your lifetime or spread them out over a five-year period. If you take the five-year option, you may have to fully withdraw all of the account assets by the end of the fifth year following the account owner’s death. In either case, you’d pay income tax on the withdrawals.

You could also roll the account over to an inherited IRA, if the plan permits this. Here, the RMDs would be based on your life expectancy, assuming the account owner hadn’t started taking them yet. If they had started with their RMDs, you’re required to continue taking those distributions. However, you could base the distribution amount on your life expectancy, rather than that of the account owner.

Speak with an experienced estate planning attorney to help you determine the route that makes the most sense to reduce taxes, while planning ahead for the future.

Reference: Smart Asset (October 22, 2019) “A Guide to Inheriting a 401(k)”

What Will New Acts of Congress Mean for Stretch IRAs?
Retirement On Calculator Showing Pensioner Retired Decision

What Will New Acts of Congress Mean for Stretch IRAs?

The SECURE and RESA acts are currently being considered in Congress. These acts may impact stretch IRAs. A stretch IRA is an estate planning strategy that extends the tax-deferred condition of an inherited IRA, when it is passed to a non-spouse beneficiary. This strategy lets the account continue tax-deferred growth over a long period of time.

If a parent doesn’t need her Required Minimum Distributions, does it make sense to do a gradual Roth IRA conversion and use the RMDs to pay taxes on the conversion? Or should the parent invest the RMDs in a brokerage account?

There are several options in this situation, according to nj.com’s recent article, “With Stretch IRAs on the way out, how can I plan for my children’s inheritance?”

Congress is considering legislation with the SECURE and RESA Acts, that would eliminate the ability of children to create a stretch IRA, one that would let them to stretch distributions from the inherited IRA over their lifetimes.

Under the proposed SECURE and RESA Acts under consideration, the maximum deferral period will be 10 years. If the beneficiary is a minor, the period would be 10 years or age 21.

The best planning strategy for a parent would depend on her overall finances and what she wants for her children’s inheritance.

The conversion to a Roth may be a good planning move, depending on her tax bracket. Putting the money in a brokerage account is also an option.

A parent may also want to think about using the RMD proceeds to purchase a life insurance policy held by an irrevocable trust for the benefit of her children.

It’s best to contact an experienced estate planning attorney, so he or she can review the details of the parent’s finances and help her choose the best options for her situation.

Reference: nj.com (October 15, 2019) “With Stretch IRAs on the way out, how can I plan for my children’s inheritance?”