Many of our clients saved for retirement in a company 401k that was moved into an individual retirement account (IRA) when they stopped working. At the end of 2022 of the 37 trillion dollars in retirement assets in the country, 11.5 trillion were in IRAs. As money gets pulled out of these accounts they are taxed as income. Once a person turns 73, they are required to distribute funds and pay taxes on an actuarial basis. Uncle Sam likes to collect his coins.

Up until 2020 the people who had inherited IRAs could push out the distributions for decades and continue to receive the benefits of compounding wealth on money that had not been taxed. This ended with the passing of the SECURE act in 2022 and in most cases, there is a 10-year mandatory drawdown for inherited IRA’s.

The SECURE act still protects the spousal exemption, but all other beneficiaries will need to pull money out of the inherited IRA in year one. The tax consequences for this vary but as an example consider the 55-year-old high earning executive who inherits his parent’s $500,000 IRA. In year one they will have an additional 50,000 in taxable income. It is a nice problem to have, but still strikes us as a problem that could have been avoided, especially in states with high marginal income tax rates such as New York and California.

Here are a couple of ideas:
Assuming your parents have a trust, analyze the ratio between the trust’s assets, any IRA assets, and any real estate. Based upon the distribution of wealth, a ROTH IRA Conversion may make sense. Inherited ROTH IRA’s still need to be drawn down, but the taxes have already been paid.

Several positive outcomes can occur from this analysis:
Conversations about money between aging parents and their heirs can languish for years. Both sides can feel uncomfortable, but most can agree they don’t want to pay unneeded taxes. Using the changes in the tax code as a reason for meeting can ease the tension.

There is a general apathy with estate planning beyond having a trust established and funded given the combined federal estate tax exemptions are currently $13.61 million per spouse. The perception is that the heirs will not pay any taxes, and yet in many cases much of the inherited wealth sits within an IRA.

Here are several more resources on the Secure Act and if you would like to have a ROTH Conversion analysis done, please let us know.

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