“The difference between death and taxes is death doesn’t get worse every time Congress meets”. This famous quote from Will Rogers seems especially true today as state and federal governments never seem to run out of ways to tax and spend our money. A recent example of this are so-called “death taxes”. With the significant increase in the federal estate tax exemption ($5.43 million in 2015), many people assumed that death taxes were largely a thing of the past (at least until Congress changes the law again). However, despite the increase in the federal estate tax exemption, many heirs will still face large tax bills. Primarily, this is due to the income taxes that must be paid on inherited retirement accounts, such as IRA, 401(k), 403(b) accounts.
If you die owning a traditional retirement account, income taxes must be paid by your beneficiaries on the withdrawals. Currently, non-charitable IRA beneficiaries can make withdrawals over their life expectancy – by utilizing a so called “stretch” IRA (not available for most 401(k) plans). However, this tax problem could get significantly worse if Congress kills off the stretch IRA – and many experts believe it is just a matter of time before it does. In fact, the White House proposed eliminating the stretch IRA in 2013 and again this year.
With retirement accounts being the second largest account for many retirees or near retirees, this is very bad news for their beneficiaries. Imagine a $250,000 retirement account being withdrawn over a five year period ($50,000 per year) subject to state and federal income taxes that depending on the beneficiary’s tax bracket, could exceed 40%. Potentially paying over $100,000 in taxes from a $250,000 IRA makes Will Roger’s quote seem tame.
What can be done? A recent Wall Street Journal article titled: “Death and Taxes, the Sequel”, recommended three key strategies that investors should consider.
- Tap your retirement accounts first.
- Convert part of your IRA to a Roth IRA.
- Consider leaving IRA money to charity.
Every situation is unique and careful planning is critical. The goal, of course, is to keep more of your money by paying less in taxes. To determine what is the best strategy for you, be sure to consult with an experienced elder law attorney.