I have never heard anyone say, “when I’m gone, I want my wealth to go to the US Treasury.” That may be exactly where your 401k and/or IRA will end up. The SUCURE Acts have enacted IRS inheritance tax rules that are much more complex and expensive for families who have lost loved ones since 2020. These new rules were an attempt to increase tax revenues from beneficiary retirement accounts through Required Minimum Distributions (RMD) and the 10-year rule. In addition to the complex rules, a mistake will likely be irrevocable and could incur excise tax penalties and interest charges in addition to taxes that may be owed.
Most non-spouse beneficiaries will face the default 10-year rule. The 10-year rule requires the beneficiary to withdraw the entire inherited retirement account balance by the end of the 10th year following the year of the owner's death. The SECURE Acts largely eliminated the "stretch IRA" (taking distributions over the beneficiary's life expectancy) for beneficiaries inheriting a 401k and/or IRA from a loved one who passed in 2020 or later. There is an exception for Eligible Designated Beneficiaries (EDB) who have options to stretch their RMD’s beyond the 10-year rule.
If you have a large 401k and/or IRA balance that passes to your heirs, they will think they won the lottery and will be taxed as if they did. That means they could end up paying a tax rate far higher than the maximum tax bracket for their Federal and state income taxes. Except that’s your money. You worked hard for it, and you deserve to have it help the people you love. It could be used to help your grandkids afford a higher education, your kids
A trust is considered to be a non-spouse beneficiary subject to the 10-year rule. A trust may have higher tax rates on RMD distributions.
How can you make sure your legacy plan is secure?
Tax rates are near the lowest they have been over the last century. When you consider the increasing US deficit spending, the potential insolvency of social security as baby boomers retire, and increasing healthcare costs, tax rates are likely to increase in the coming years. You may consider taking advantage of today’s tax rates and act before tax rates begin to increase.
Consider some financial planning strategies to transfer your balances into accounts that are not required to take RMD’s such as non-retirement accounts. You may consider Roth conversions that allow you to rollover all or part of your non-Roth accounts into a Roth account. However, you will have to pay ordinary taxes on the pre-tax amount you convert. Before you do a conversion, you will want to plan ahead so you do not end up paying more than what makes sense for your situation. Additionally, most inherited Roth IRAs are still subject to RMDs. However, distributions from inherited Roth IRAs are not taxable and are much less of a tax burden on your beneficiaries.
If you are charitably inclined to give all or part of your savings to your church, alma mater, non-profit, or favorite charity, you can plan to strategically make gifts to your 503(c)(3) non-profit from your IRA. Since non-profits do not pay taxes on donations, they will receive all the money you donate.
Talk to your financial advisor about your goals to get the help you need to implement a legacy plan that will work for you.
