How Good Is Your Family at Discussing Finances?

Honestly, most of us dread, delay, or consciously avoid any discussion with our kids about our finances and particularly about their inheritance. Money is not an easy subject to broach. The topic often brings the fear that there may be a huge argument, feelings may get hurt, or even worse. However, the lack of any input from them could bring unwanted consequences.

If your assets will contribute to the Great Wealth Transfer, the trillions of dollars that will flow from older generations to heirs and charities through 2048, then it is essential that you get input from your beneficiaries.

Inherited IRAs

The rules for if/when your IRA beneficiary must begin taking required minimum distributions and/or distribute all the account assets depend on their beneficiary classification:

• Eligible Designated Beneficiary (spouse or minor child of the original account holder, or an individual that is disabled, chronically ill or no less than 10 years younger than the original account holder)
• Designated Beneficiary (most other individuals)
• Non-Designated Beneficiary (trusts and organizations)

The 2019 SECURE Act, which went into effect on January 1, 2020, came with several changes for inherited IRAs. Your IRA beneficiary will now generally have 10 years after your death to withdraw ALL the money. That is also true for both Traditional and Roth IRAs. Otherwise, they’ll face a penalty on any money remaining in the account. However, this rule does not apply to those listed above as Eligible Designated Beneficiaries. They have other options. The rules are also different for Non-Designated Beneficiaries.

There are additional nuances based on the beneficiary’s relationship to you, when you die, and their age at the time of your death. Your heirs’ options may also depend on whether you have reached your Required Beginning Date (RBD – date at which Required Minimum Distributions must begin) at your death. The best thing both you and your beneficiaries can do is to talk to both a tax and a financial advisor. You do not want to create undesired tax consequences with decisions made too quickly and without the beneficiary’s input.

Traditional IRAs

For example, imagine the bulk of your assets are housed in a Traditional IRA. Would it make more sense for you to name your grandchildren as beneficiaries versus your children? How old are your children and your grandchildren? Do any of them qualify as Eligible Designated Beneficiaries? In some situations, a trust might be named the beneficiary. The rules for Non-Designated Beneficiaries would then apply.

There are questions that play into an appropriate beneficiary designation. What is the size of the IRA that will be inherited? Do the beneficiaries desire to inherit? What is your intent for the use of your assets after your death? What are the tax brackets of each beneficiary and how close are they to moving into a higher bracket?

Let’s imagine your current Traditional IRA beneficiaries are your children. They are all adults and are not disabled or chronically ill. Over the 10 years that Inherited IRA withdrawals are required for each of them, would the dollar amount, which must be reported as ordinary income, push your children into higher tax brackets? Would that create a burden for them?

Perhaps they could manage their withdrawals strategically to place the tax burden in one or two years versus taking some out each year. That flexibility is only available, however, if you have not reached your RBD at your death. Otherwise, an RMD is required each of the 10 years. Of course, they always have the option to take a lump sum distribution at any time within the 10-year time frame.

Those strategy decisions should be discussed with their tax advisor. You would do your children a favor if that discussion and appropriate decisions are made by them before your death. That could make a stressful time easier for them. It is also important to make sure your beneficiaries know to check if you have taken your required minimum distribution for the year of your death (if it is required). If not, it must be taken before any distribution of assets to beneficiaries, otherwise penalties could apply.

Roth IRAs

Roth IRAs create some different questions. No income tax is assessed on distributions of contributions from Roth IRAs, but earnings could be taxed if the Roth account is less than five years old. In your discussion with tax and financial advisors, perhaps a conversion of some of your Traditional IRA assets to Roth IRAs makes sense. Because you pay the income taxes on the value of the assets included in the conversion, it could eliminate the associated tax consequence to your beneficiaries, provided you expect to live at least five years after the conversion.

Spouse Beneficiaries

Spouses have the most flexibility as beneficiaries. However, it is important to discuss all options with a trusted advisor, too, or even better – have that conversation before either one of you die. The husband of a woman I know died after a long illness. She had not been actively involved in the couple’s financial life. My friend was the sole primary beneficiary of his Traditional IRA and was incorrectly told that she needed to make a complete withdrawal of his entire IRA balance at once. Her tax burden is enormous!

One of the options she had was to move his assets to her Traditional IRA and, in effect, take ownership as if they were her assets. That is called a spousal rollover. There are NO tax consequences with that transfer. She, of course, must make RMDs on the new combined balance, if she is of RMD age, and that could increase her income taxes. Other spousal options are laid out on the IRS website referenced below.

You can find the rules for beneficiaries of IRAs – both Traditional and Roth – as well as qualified retirement plans (like 401(k) plans) and trusts using this link: https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-beneficiary. Note that the site still shows rules for beneficiaries when the death occurred prior to 2020. Do not confuse those rules with ones that apply to you.

There are so many nuances to beneficiary designations, and it is essential that a competent tax and financial advisor are consulted. But it is equally important for your beneficiaries to be involved so they have a clear picture of their necessary steps and the tax consequences involved.

Questions:

Have you had any discussion with your IRA beneficiaries about their inheritance wishes? If so, do you have any tips to pass along to make those meetings easier and more productive?