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Making big financial decisions immediately following the death of a close family member can be dangerous. It is often best to allow some time before tackling big financial decisions. On the other hand, some people find getting immersed in the finances is helpful in coping with the loss. Whatever way is best for you, you will need to give it your
careful attention to avoid big financial mistakes. The different types of accounts have different rules. I'll address the most common types. In the case of the death of a parent or anyone other than your spouse in which you are a non-spouse beneficiary, there are many rules that you must know to make the best decision for you and your family. (In this article, I use the common parent-child inheritance, but the planning strategies can apply to other non-spouse situations.) Your decisions can have major tax and investment consequences, both now and in the future. And some of these decisions have time deadlines keyed to your parent’s date of death. Also, some of these decisions are irreversible. You can download my free Estate Planning Survivor Checklist here.
So, you don’t want to rush in and make decisions without knowing the rules, and you don’t want to wait too long and be stuck with fewer options. (In this article, I am not addressing estate taxes. As of 2021, only estates valued at $11.70 million or more are subject to federal estate tax. But there are plenty of other tax pitfalls to navigate around. I am also going to focus on liquid savings like investment and retirement accounts, versus real estate which will be for another time.) Sign up to receive my free monthly email articles on retirement planning--no cost, no obligation. |
For cash and non-retirement accounts you inherit, the biggest potential tax problem is not going to be income taxes associated with the transfer of the assets to you; rather, it is capital gains taxes when you sell the assets.
As I mentioned earlier, most taxpayers will not be subject to a Federal estate tax liability, but the estate and/or beneficiaries can have big Federal income tax liabilities that can be reduced with good planning. So, cost basis management is critical in maximizing the step-up in basis, as well as minimizing the loss of any unrealized and/or carryforward capital losses. See more on preserving capital losses here.
Currently, at death, there is a step-up in the cost basis of the securities in the account, which means the capital gains your parent had are essentially wiped away at their death and the gain/loss calculation starts over with the fair market value of your parent’s investments at his/her date of death.
If you continue to hold your parent’s investments, and there is a big gain after they die, selling a stock within a year or less will count as short-term gains on your tax return, which is the same as ordinary income rates, which is higher than long-term capital gains rates.
This is something to explore carefully before deciding to sell or hold your parent’s investments. All of your share of your parent’s taxable accounts (if they have more than one account) could theoretically be transferred into one taxable account in your own name. No special accounts need to be opened because of inheriting the assets.
The cost basis information is typically transferred to the account in your name. Afterwards, interest and dividend income, and gain/loss data, is recorded and reported via a 1099 each year. This also could present a tax problem for you that you'll need to address.
Inheriting after-tax monies can create many tax planning opportunities for you such as paying taxes and/or living off those monies while you do strategic Roth conversions in lower tax years. People with too little after-tax monies often struggle to be able to implement these strategies.
If your parent had a Pay on Death or Transfer on Death on the account, the assets could transfer immediately to the beneficiaries and avoid probate. This is an easy way for your parent to save you time and money in their estate disposition process.
(I am assuming that the assets are not in a trust, which I am not addressing here.)
The SECURE (“Setting Every Community Up for Retirement Enhancement”) Act was signed into law in December 2019 as part of the 2020 federal budget. This law virtually killed the lifetime tax-deferred IRA stretch for non-spouse beneficiaries (like children), except for a few cases.
Otherwise, non-designated beneficiaries like estates, charities and nonqualified trusts have 5 years to distribute the assets. All other designated beneficiaries must take distributions within a maximum 10-year period.
Read more about the death of the stretch IRA here.
Unfortunately, ten years is shorter than the normal life expectancy; but the one good part of the new rule is there are no minimum distribution requirement each year.
The new law just requires that the beneficiary IRA monies be distributed by the end of the 10-year period--or else huge penalties will be levied (on top of the taxes in the case of traditional pre-tax IRAs). Compared to the stretch option before the SECURE Act, IRA and 401k monies now have a shorter period to defer taxes and spread the tax burden.
If you are close to retirement when you inherit a big IRA
from your parent, you might delay Social Security while you
take heavier beneficiary IRA distributions in the gap years between retirement (when you stop working full time) and your larger and later Social Security payments (due to delaying). You are looking to
flatten the tax curve to avoid big income spikes or gradual creep into the higher marginal
brackets.
If the inherited retirement account is big enough, it could tempt you to retire a few years early to pursue other endeavors while taking distributions at a lower tax rate.
If you are in your peak income-earning years with no desire or plans to retire within ten years, you may want to spread the distributions more evenly over the ten years (it could be 11 tax years if timed properly) to flatten your tax curve.
If you are already retired and past “full retirement age” as deemed by Social Security, you may consider suspending your Social Security to take higher distributions from your inherited IRA. This would kill two birds with one stone: lowering your lifetime taxes while getting delayed Social Security credits, thus increasing your Social Security income 8%/year up to age 70. See “How to Maximize you Social Security Income”.
The goal is to figure out the best way to minimize your lifetime taxes and maximize your income/assets. This requires projecting your income and tax liability over your entire retirement. See more on tax planning.
For IRAs, there are IRS letter rulings that allow IRAs with no named beneficiaries (i.e., if your parent did not name any beneficiaries on his/her IRA) to continue to be stretched by you (the beneficiary) using your parent’s (the decedent’s) Required Minimum Distribution (RMD) schedule versus the 10-year rule. Some IRA custodians, however, may not be cooperative in helping you implement this. But for parents that die in their 70s, this RMD schedule can extend the tax deferral longer than 10 years. See Michelle Ward’s article here.
As for the mechanics, you need to establish an individual beneficiary IRA linked to your parent and so titled. While you can usually combine your mom’s IRA assets into one beneficiary IRA linked to your mom, make sure you don’t combine your different parents’ IRA monies in the same beneficiary IRA account. Each parent's monies need a separate beneficiary account linked to that parent. You also need to make sure the inherited IRA monies do not get transferred into your own non-beneficiary IRAs. The 10-year rule (or RMD schedule) will be based on each parent's date of death.
Note: The benefit of deferring taxes is that you get compounded growth on the money you would have paid in taxes each year. It is especially beneficial if you are in a higher tax bracket now (due to high earned income, for example) than you will likely be in retirement or during the gap years between retirement and the beginning of Social Security and/or RMDs on your own retirement accounts.
Also, with inherited Roth IRAs, there are no taxes upon distribution, but there is now a shorter time to enjoy the tax-free growth. So, the best strategy for inherited Roth IRAs will be, in most cases, to take no Roth IRA distributions until just before the end of the 10-year period, and then take one big distribution to empty the account.
Nonqualified annuities are annuities that are not in retirement accounts like IRAs.(IRA inheritance rules apply to annuities within IRAs).
Nonqualified annuities are tax deferred and at death will normally have Income with Respect to the Decedent (IRD) taxes to manage. The cost basis (typically the initial investment) is not "stepped up" as are securities in individual taxable accounts. These assets are treated differently than IRAs and taxable accounts.
Fortunately, however, nonqualified annuities were not included in the SECURE Act’s stretch-killing laws, so you may be able to continue the annuity’s tax deferral (with the same insurance company and/or product or do a 1035 tax-free exchange to another insurance company and product) and stretch the tax deferral over your lifetime with an RMD schedule based on your life expectancy.
The RMD schedule is based on your age and requires an ever-increasing percentage to be distributed and reported as ordinary income each year until the assets are depleted.
To take advantage of this extended tax-deferral and the "spreading out" of annual taxable income distributions, a separate annuity policy needs to be established in your name and linked to your parent who owned the original annuity. The cost basis of your parent would be transferred to your annuity (or rather your proportionate share of the cost basis based on your beneficiary share).
If you choose the lifetime stretch, the first RMD is due within a year of the date of death. There is 50% penalty on missed RMDs, so they should be automated if possible, to ensure they are not overlooked.
Other options are available other than the lifetime stretch. However, if you face a high IRD, a lump sum distribution or even 5-year payout could push you into high tax rates. In such cases, the lifetime stretch gives you the option to stretch the deferral, flatten your tax curve, all the while being able to take bigger distributions in low tax years. The stretch option for high IRD inherited assets will usually give you maximum flexibility.
For more on how nonqualified annuities are taxed, see my article, Are Annuities a Good Investment? The Good , the Bad, and the Ugly.
1. If you have recently inherited your parent’s
investments, be sure to know all the rules and all your options before making
decisions about their accounts. The rules are complex, and the IRS is typically
unforgiving if you make mistakes. Also, don’t miss RMD deadlines or transfer deadlines, like the
one-year deadline many companies require…or you could get killed in penalties and/or extra taxes you could have avoided.
2. Make your decisions in the context of your own customized financial plan, based on your goals and situation. Even if you know all the rules and options available to you, it may be impossible to choose the best course for you without a financial plan that includes a 10-to-20-year tax projection.
3. If your parents are still alive, explore helping them develop a financial plan that includes estate and tax planning. Your parents’ hard-earned wealth can go to entities they didn’t desire and/or complicate your life greatly if they make mistakes like: a) missing or not updating out-of-date beneficiaries on accounts and policies, b) having no “Transfer/Pay on Death” for bank and taxable investment accounts, c) having big unrealized capital losses that will be stepped down and lost, d) scattered, unconsolidated, and uncoordinated accounts in different places for no good reason, etc.)
4. Plan your own wealth transfer legacy for your children with these realities in mind. Involve them in the process as much as possible. Also, knowing your children's tax situations can help you bequeath your investments in a more tax-efficient way.
5. Unless you are one of the few individuals who love to geek out in researching and implementing these complex strategies, hire an advisor. Be sure to find an advisor who specializes in tax planning (which greatly narrows the field). If you are not willing to do the research, then don’t be penny wise and pound foolish, trying to save a small portion of what you can potentially lose by winging it. Even if you can do it yourself, your spouse or children could be lost and taken advantage of if something happened to you. The value of a great advisor far outweighs the price.
Investment Advisory Services offered through JT Stratford, LLC. JT Stratford, LLC and Echols Financial Services, LLC are separate entities.
Here is an executive summary of how to build up a portfolio for retirement in seven steps.
1. Values clarification and goal-setting . Figure out the income objective and capability of your retirement assets in lifestyle terms, then financial terms. In other words, set realistic, specific, financial goals based on your core life values.
2. Asset allocation glide path . Figure out how to diversify your retirement assets among stocks, bonds, and cash, based on your age, risk tolerance, retirement goals, and changing market values.
3. Valuation-dependent efficient frontier . Figure out which areas of the markets are historically inexpensive, and which are historically expensive. Don’t take on more volatility than you need to for the growth you need or desire.
4. Multi-asset class approach . Diversify one more step for more growth and less volatility. Put more money in the specific market areas that are less expensive and less money in the specific market areas that are more expensive.
5. Tax-aware asset location and distribution . Save as much on taxes as possible by figuring out which type of investments should be held in which types of accounts. If you are drawing an income from your assets, figure out the least-costly order for making withdrawals.
6. Investment selection based on account type (qualified, nonqualified) and asset-class propensity and magnitude of outperformance (passive, factor, managed, etc. ). Figure out what kind of investment to use (index mutual fund, factor mutual fund, actively managed mutual fund, single factor ETF, multifactor ETF, passive ETF, individual stocks, individual bonds, Unit Investment Trust, closed-end fund, etc.) based on the account type, asset class, and growth and income needs.
7. Rules-guided rebalancing based on retirement glide path and multi-asset-class approach . Readjust the investment mix based on your changing personal situation and changing market values.
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Here is a summary of the details backing this approach. Also, click here for more background information regarding my investment philosophy.
1. Values clarification and goal-setting
Investment planning for (or in) retirement starts with retirement planning. You start with thinking about your life goals...your dreams...your ideal life in retirement. It could involve doing no work, working part-time, or doing seasonal work. Your ideal life could be going back to school, spending more time with family, traveling, ministry, etc.
Ask yourself questions like, "What would I want to do if I
didn't need to work for money?" or "What are the most important
dangers, opportunities, and strengths I need to address?" or“Ten years from now, if I am looking back on a successful
ten years, what will I have achieved?”
This conversation allows you to create specific
goals around your most cherished values. And your goals will be unique to you.
You then design an investment plan to help you live your ideal life.
This kind of goal-focused, plan-driven approach minimizes the
chances of making bad investment choices based on current events and emotions.
Instead, you can choose and maintain the
specific mix of investments that can best deliver the results you need--using a
disciplined, research-driven approach.
2. Asset allocation glide path
The next major question is what kind of investments do you need to meet your goals. All investments have risk. Even "safe" investments over long periods have inflation risk. No single investment delivers growth, high income, and safety of principal. The key is designing a portfolio that balances them in a way that supports your retirement objectives.
And this mix may change over time. For example, for most people, it makes sense to gradually decrease their exposure to high-growth, high-volatility assets like stocks (i.e., equities) as they approach retirement. In retirement, it is usually best to maintain a flat equity glide path, dynamically adjusted for valuation. This approach protects you from the retirement-danger-zone risks of portfolio size effect and sequence risk, while allowing you to take advantage of bear markets and market corrections. See How to Navigate the Retirement Danger Zone .
Protecting your lifetime retirement savings from excessive taxes is a crucial part of holistic financial planning. This involves protecting your IRA, 401k, lump sum pension rollover, Social Security, and any other type of retirement account or income stream from crushing tax rates.
So let's be sure to differentiate tax preparation
from tax planning
.
Tax preparation , also called tax return preparation, looks backward, one year at a time, to get the numbers right to accurately calculate your tax liability (and how much you owe or overpaid).
Tax planning on the other hand looks at taxes in the context of your overall financial picture. A tax planner not only looks in the rear-view mirror but will look forward 20 to 30 years at your projected tax liability and ask what can be done to lower your lifetime tax bill.
If you have savings outside of pretax retirement accounts invested in capital assets (like stocks, bonds, ETFs, mutual funds, precious metals, jewelry, and real estate) which have large unrealized capital gains, this article is for you. You may be missing the opportunity to pay zero taxes NOW instead of 15% or higher rates in the future. Sign up to receive my free monthly email articles on retirement planning--no cost, no obligation
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Originally written on Aug 2, 2018 and updated for tax law changes.
If you are no longer working and have reached the age of 72,
you probably know about Uncle Sam’s rule for you to take a Required Minimum Distribution
(RMD) from your traditional and rollover IRA(s) each year for the rest of your life. You can always withdraw more,
but this requirement is the minimum
you must take or be severely penalized. Fortunately,
this rule does not apply to Roth IRAs. (The SECURE Act of 2019 changed the starting RMD age from 70½ to 72 starting in 2020, but fortunately you can still make a Qualified Charitable Distribution (QCD) starting the year you turn 70½.)
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If you have delayed paying taxes in your pretax IRA, 401(k), or 403(b), etc, there comes a time when the IRS wants their taxes. And if you don’t give them their taxes based on their required withdrawal schedule, you'll get hit with a 50% penalty on top of what you owed.
Along with Social Security and other retirement income, this RMD can significantly raise your tax rate. Also read How to Dodge the Social Security Tax Torpedo . There are not many ways to reduce this tax burden. In the past, retirees have used various deductions including charitable cash contributions and gifting of highly appreciated assets to charities. (The latter not only gives you, the donor, a deduction but also avoids a long-term capital gains tax bill.)
However, with the passing of the Tax Cuts and Jobs Act of 2017 (TCJA) , with its almost doubling of the standard deduction, itemizing deductions won’t make sense for near as many retirees. Ah, but there is still a strategy. But first let’s better understand the RMD.
The latest book I am reading is “ The Psychology of Money ” by Morgan Housel. Chapter 3 is entitled “Never Enough”. In this chapter, Housel talks about when rich people do crazy things. He tells stories of wealthy people who never had a sense of enough and wrecked their reputations, families, freedom, and happiness because of it. I have also talked to older couples who tell me they once had a much better retirement in view, but the quest for more led them to make unwise investment decisions that left them financially crippled in retirement. The importance of knowing when you have enough is not only vital to when you retire but also how you retire. It can affect how you invest, how you withdraw, and your overall satisfaction before and during retirement. Be sure to read to the end where I summarize a few key takeaways. Housel makes the four following observations in chapter 3 of his book. Sign up to receive my free monthly email articles on retirement planning--no cost, no obligation
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Whether you do mini-Roth conversions over several years or big Roth conversions in a few strategic years, the Roth conversion strategy could save you tens if not hundreds of thousands of dollars over your retirement. This article will get deep into the issues of Roth conversions for retirees and the ten steps to take to be sure it is done properly. Be sure to scan or read to the end where I will give you the simple answer to getting your Roth conversion questions answered. Sign up to receive my free monthly email articles on retirement planning--no cost, no obligation
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Delaying Social Security makes a lot of sense for many retirees; but there are common pitfalls that can cost you a bundle. As you know, the longer you delay your Social Security Retirement benefit, the higher your lifetime monthly payments are figured to be. This increase in delaying continues until age 70, after which there are no further increases for delaying. This increase for each month that you delay filing is not small, especially considering the current low interest rates. Even after full Social Security age, your payment goes up by 8% per year until age 70. Sign up to receive my free monthly email articles on retirement planning--no cost, no obligation . Here are the five big mistakes of delaying your Social Security retirement benefit. |
Are you wondering about the impact of the
2020 election results on your retirement? If so, you are not alone. The two political parties are greatly polarized. While the Democrat party has moved further toward ethno-centric socialism, the Republican party has moved further toward nationalistic populism. The difference in the two parties’ goals for our country is wider than ever. Sign up to receive my free monthly email articles on retirement planning--no cost, no obligation . |
If you are like most Americans, when you retire and stop earning income, Social Security will be one of your most valuable assets. There are many little-known facets of how Social Security works, how it applies to you, and questions regarding how to best use your Social Security benefits. Often the various questions swirling around the idea of Social Security can feel overwhelming. As you plan for your own, your spouse’s, and your family’s protection as you age, it is important to know the available Social Security benefits that might be available to you and your family. It is also important to know what becomes of those benefits when you die. To help you, I am going to discuss three commonly asked questions. Sign up to receive my free monthly email articles on retirement planning--no cost, no obligation . |
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Investment Advisory Services offered through JT Stratford, LLC. JT Stratford, LLC and Echols Financial Services, LLC are separate entities.
Serving Cumming, GA, Forsyth County, and the surrounding areas of John's Creek, Alpharetta, Milton, Duluth, Buford, Suwanee, Flowery Branch, and Gainesville