Will that be cash or credit? For many years now, I have paid even my most minimal purchases on credit, not cash. While placing $2.95 on my credit card for a doughnut and coffee still seems a bit odd, at last I avoid taking the extra time to run to the cash machine. Of course, once the credit card statement is received at the end of the month, the cumulative effects of the caffeine and sugar kicks I enjoyed over the previous month are a distant memory.
Estate planning has numerous “pay now or pay later” conundrums, including the decision of when to withdraw assets from tax-deferred retirement accounts. If the current tax bill making its way through Congress is enacted, individuals with significant balances in their IRA, 401K or other tax-deferred accounts should review and perhaps reconsider how their retirement account planning impacts their overall estate plan. Among other important provisions of the “Setting Every Community Up for Retirement Enhancement” (“SECURE”) Act, the bill would require that, following the death of the account owner and his or her surviving spouse, the entire retirement account must be withdrawn within ten years.
As I have summarized previously, tax-deferred retirement accounts are taxed only as the account owner withdraws assets. Following the death of the original account owner, the new account owner(s) are likewise taxed only as they withdraw assets. These new account owners are required to withdraw a required minimum distribution (“RMD”) on an annual basis, which is generally based upon his or her life expectancy. By withdrawing only the RMD, the new account owner can “stretch” the retirement account over his or her lifetime, thereby minimizing the income tax burden. However, if the SECURE Act is enacted in its current form, it would effectively eliminate the opportunity to “stretch” the tax-deferred account, thereby significantly increasing the family’s overall income tax burden.
If the SECURE Act is enacted, individuals with significant retirement account balances might consider the following strategies:
- Withdraw More IRA Assets During Retirement. First, retired IRA owners might consider withdrawing a greater amount of retirement account assets now, during retirement, and “take it for the team,” so to speak, by paying the tax liability sooner rather than later. Once the retirement account assets have run the gauntlet of state and federal income tax liability, the account owner has a number of options beyond his or her own consumption of the assets during retirement, including (i) the purchase of permanent life insurance, (ii) contributions to tax-favored investment or savings accounts for themselves or family, such as Roth IRAs or 529 Plans, or (ii) direct lifetime gifts to children or grandchildren.
- “Spread” Rather than “Stretch.” Second, IRA owners should reconsider the appropriateness of their current beneficiary designations. While it would no longer be possible to “stretch” one particular beneficiary’s inherited IRA account, it may be worthwhile to “spread” the entire account across a greater number of beneficiaries. Provided such beneficiaries are capable of receiving the assets and are not already at the top marginal income tax bracket, spreading the wealth across multiple adult beneficiaries might enable the family to collectively reduce its total income tax burden.
- Designate Charity as the Beneficiary. Third, and finally, IRA owners should consider naming a charity (or charities) as the beneficiary in order to achieve their charitable objectives. As I have written previously, one of my favorite strategies for charitably-inclined clients is to designate one or more charities as the beneficiary of tax-deferred retirement accounts. While Jesus told us to “pay onto Ceaser what is Caesar’s,” Ceasar’s rules for Rome most assuredly did not include a precursor to Internal Revenue Code Section 501c(3). Charitable gifts are the big exception to the “pay me nor later” conundrum, since the use of retirement accounts will pass to the charitable beneficiary, free and clear of any income tax liability.
My wife Heather and I are already looking ahead to next winter and planning a mid-winter vacation. In our case, we will be paying for the trip ahead of time. What better vacation is there than a vacation that has already been paid for? Your clients and their children might be encouraged to engage in a similar conversation about the pros and cons of paying income taxes now versus later or, alternatively, reconsidering beneficiary designations on retirement accounts.