Does this look like the plan for your IRA?
Amass as much money as you can, compounding interest and deferring taxes until you retire. At that point, you’ll likely be in a lower tax bracket, so you will receive a higher payout. Everything you don’t need will go to your children.
I Hate to Burst your Nest Egg…
…but things may not turn out as you planned. Here are a few scenarios to consider (and plan ahead for):
Scenario 1: You have more income than you thought you would; you are still in a high tax bracket at the time of your withdrawal, and still lose 37% of your IRA to taxes.
Scenario 2: You never end up needing your IRA, but at age 70 1/2, you are forced to make withdrawals or you will face a penalty of 50%. In that case, half of your minimum payout amount, less what you withdrew that year, goes to the IRS!
Scenario 3: You take out the required minimum at the designated age, but the remainder keeps growing and becomes part of your estate.
If your estate is more than around $11m (after 2025), your heirs will have to pay 40% of it to the IRS. That is in addition to the income tax that had been deferred; now payable by your beneficiaries. So if your beneficiaries need to liquidate some assets to pay the estate taxes, they may incur income taxes as well, creating a vicious cycle (see below). The result? Your largest beneficiary could turn out to be the IRS. If it makes you feel any better, at least you’ll help keep the government going another few seconds.
Tax Taming Tips
Here are a few things you can do to minimize IRA erosion:
- If possible, name a younger beneficiary.
Your required minimum withdrawal amount (after age 70.5) is calculated based on your life expectancy. The longer your life expectancy, the less you are required to withdraw each year from your IRA.
If your spouse is more than 10 years younger than you, you can use a joint life expectancy calculation to determine your minimum distribution amount per year. Since they are expected to live longer, you get to stretch out your distributions over a longer period (and keep more money in the account compounding).
For example, let’s say you have $10m in your IRA, and your life expectancy at age 70.5 is 26.5 years. You would have to withdraw $377.4k that year to avoid the IRS penalty (note that you will have to recalculate the minimum withdrawal each year). If you name your 55-year-old wife as your beneficiary, you get to add several years to your joint life expectancy. With a new life expectancy of 30.9, you only have to withdraw $323.6k in the first year, saving over $50k in the first year alone.
- Factor in estate and income taxes.
If you have to pay estate taxes on your $10m IRA, only $6m will remain to be passed on to your children. However, if you buy life insurance (within an irrevocable trust) to cover the estate taxes, your children will receive the full $10m. If you are married, buy a second-to-die policy so it pays out only after both spouses have passed away.
When you (or your spouse) die, and your children inherit your IRA, the life insurance policy will pay the estate taxes due on the assets. That way, the kids will not have to withdraw funds from the IRA (or liquidate other assets) to pay estate taxes. They can then set up the IRA for long term tax deferral (Step 1 above). If they don’t have to withdraw funds from the IRA, they will not incur income taxes.
For example:
Let’s take the same $10m IRA and assume your heirs would have to pay $4m in estate taxes. If they have to liquidate part of the IRS to pay the estate taxes, income tax will be payable on the withdrawn amount. If your children are in the 37% tax bracket, this could mean they could also incur $1.48m in income taxes (just to pay the estate taxes). In all, they may have to liquidate over $5m of the initial inheritance to pay Uncle Sam. They could be left with less than half the original inheritance!
Instead, your life insurance policy could pay out a death benefit of $4m, and your children could keep the full $10m. Let’s look at the difference this could make; if they earn 5% on the money for 40 years, they could compile over $217m! If they inherit only $4.5m, they could compile about $32m; a difference of over $185m!
- Avoid income taxes altogether.
If you name a Charitable Remainder Trust [CRT] as the backup beneficiary (after your spouse), the IRA will never be subject to income taxes. This is because a qualified designated charity pays no income taxes. And the best part is, your beneficiaries receive a set income distribution over the course of their lifetime.
Note that the CRT should be in addition to having a life insurance policy to pay any estate taxes. This is because estate taxes will reduce the amount in the CRT, diminishing the total amount passed on to charity and distributed to children.
You don’t have to let the IRS get the lion’s share of your nest egg. The team at Axia Global draws from decades of experience offering wealth preservation solutions to high net worth individuals. You can call us for a confidential conversation to identify solutions tailored just for you or your affluent clients. It’s our goal to make a measurable difference in your financial life.
Note: The statements above should not be considered financial, legal or tax advice, but ideas for careful consideration with trusted advisors.
About Axia Global
J. Michael Roney, founder of Axia Global, has written a book on wealth preservation, and his calling is to craft profitable solutions for even the most complex wealth preservation and estate planning cases. Together, the team at Axia Global has nearly a century of combined experience in the financial services sector.
