The IRA: A Solid Estate Planning Tool in Times of Uncertainty

As the new administration eyes policy changes, taxpayers are scrambling to divine the potential estate tax implications. The unified exemption is at a historically high level, currently over $22 million for married taxpayers filing jointly, with a planned sunset in 2026. The Biden administration has proposed reducing the exemption to $3.5 million. Will it stay high through 2025 or drop dramatically — or settle somewhere in between?

The many unknowns make estate planning unusually challenging, but even in times of uncertainty, some strategies remain reliable. The individual retirement account (IRA) is a versatile financial tool that can help families accomplish a variety of estate planning goals. And since more than one in three households in the U.S. holds at least one IRA, this type of asset deserves a closer look.

IRAs are used most often to augment cash flow in retirement, and the SECURE Act of 2019 further enhanced the IRA’s utility for this purpose. In 2020 and subsequent tax years, there is no upper age limit for IRA owners to make account contributions. Contributions can keep growing longer, too, since account owners can wait until they reach 72 before taking their first required minimum distribution (RMD).

IRAs and Wealth Transfer

Stashing savings in an IRA can also be a smart move for those who know they won’t need the funds during their own retirement years. These account owners should consider strategies for using IRAs to achieve wealth transfer goals.

Along with its taxpayer-friendly changes, the SECURE Act altered how non-spousal beneficiaries are taxed on inherited IRAs. These beneficiaries must drain inherited retirement accounts within 10 years of the account owner’s death in most cases, with distributions taxed at the beneficiary’s ordinary rate.

If retirement is on the near horizon, it may be possible to postpone withdrawals until the beneficiary is in a lower income bracket. However, the limited window for closing out inherited accounts makes traditional IRAs less-than-ideal vehicles for wealth transfer.

Roth IRAs, on the other hand, offer advantages that leave them well suited for passing assets tax-free. Qualified withdrawals from a Roth IRA incur no federal income tax liability. In addition, the original Roth IRA owner is completely exempt from RMD rules, and surviving spouses who inherit these accounts can also opt to take no distributions over their lifetime.

Non-spouse beneficiaries of a Roth IRA face the same 10-year requirement to drain the account as beneficiaries of traditional IRAs, but since qualified Roth withdrawals carry no tax liability, inherited Roth IRAs offer greater value to the recipient.

Roth Conversion Estate Planning Advantages

Given Roth IRAs’ significant advantages, making a Roth conversion can be a tax-smart estate planning move. Converting an existing traditional IRA to a Roth IRA not only can get a substantial amount of money into the account quickly, but also allows the original account owner to prepay the income tax for the recipient.

The beneficiary then inherits the money tax-free, assuming the conversion occurs at least five years before any distribution of earnings. And by paying the income tax on those converted IRA funds, the original account owner also lowers the gross taxable estate value.

A Roth conversion requires careful consideration, as the decision is no longer reversible (another consequence of the SECURE Act). If tax rates are poised to go up, account holders may wish to spread the conversion process over several years. Market stability and other economic factors can also play a role in the decision to convert. It is critical to consider all the angles with a qualified advisor before committing to a Roth conversion.

Alternatively, families whose heirs will not need accumulated IRA savings can use these accounts to help meet philanthropic goals. Thanks again to the SECURE Act, IRA owners age 70½ and above can make qualified charitable distributions (QCDs) of up to $100,000 per year directly from the account, reducing total estate value while supporting a favorite cause. Be aware, though, that contributions to the IRA can reduce allowable QCD deductions for the year.

It is also possible to name a charity as the remainder beneficiary of an IRA so that upon the owner’s passing, the IRA pays out to the charity. The receiving organization will pay no income tax on the gift in most cases, while the estate reaps the benefits of a charitable deduction on its federal tax return.

Plan for What You Know

You can only guess at what the future holds; estate planning must revolve around what you know today. Focusing on tried-and-true estate planning tools such as IRAs can be a wise move during times of uncertainty. Contact CRI’s experienced tax team to get started crafting (or refining) a customized plan to achieve estate goals with your IRA.