Death and Taxes

July 05, 2023

I’m a Baby Boomer and currently enjoying Medicare and Social Security, both of which are funded by taxes. The seniors’ need for stability in these programs and indeed, increases, means the government will need more tax money. Couple this dilemma with the issue of the 30+ trillion dollars of national debt, and the additional trillions of new debts from the covid pandemic, and it’s certain that taxes are going to go up. 

And who is going to pay those increased taxes?  Our children!

In 2019, and again in 2022, the government passed the SECURE Act and SECURE Act 2.0. These new laws passed under the radar and were packaged and delivered as good for Americans, because one of the provisions raised the age before taxpayers were “required” to take money from their qualified plans, allowing them to defer the payment of taxation.

On the other side of the coin, how will the government pay for these added benefits?

For instance, the 2019 SECURE Act repealed the Stretch IRA. The Stretch IRA allowed non-spouse beneficiaries (our kids) to stretch the withdrawal of inherited IRA money over their lifetime and required a relatively small withdrawal, and relatively small tax payment, every year.

Now, our kids must take ALL the money from the IRAs we leave them, in 10 short years. Moreover, SECURE 2.0 requires them to take money out, and pay taxes, every one of the 10 years.  The forced withdrawal of all that money in just 10 years is a tremendous windfall for the IRS and a terrible tax burden on our kids. 

Just imagine at our death, our kids most likely will be in their peak earning years, and already paying a lot of taxes, and then they inherit our IRAs.  For example, by adding the required amount they must take from the inherited IRA to their earned income many of our kids will be pushed into the highest tax bracket. Currently, that is 37% for the Feds and 13.2% for the State of CA. Do the math! They will lose over half their annual income, to income taxes!

Prior to the SECURE Act, almost every financial advisor would have advised us to defer taxes as long as possible. Max-fund your 401-k and IRA, and only take out the minimum required so you leave the maximum amount of assets to grow, tax-deferred until death, when you could pass the assets to your children, and they could continue to take out only the required minimum and continue to defer taxation on the balance.

The SECURE Acts sent us back to the drawing board to re-strategize the financial planning fundamentals we have known and trusted.

What’s the new thinking?  Qualified accounts are great for accumulating money but not good for wealth transfer.  Maybe “deferring” taxes is not the right advice?  Consider taking money out of the qualified accounts now, paying taxes (in the lowest tax brackets of your children’s lifetimes), and investing the money differently, more tax-efficiently, in the creation of your legacy. 

Consider converting your IRAs to Roth IRAs, which will pass to your kids tax-free and not require them to pay taxes on withdrawals.  Or perhaps investing the after-tax money into stocks and securities, or real estate that will get a step-up in basis at your death and your kids will inherit those assets with no income or capital gains taxes due. 

If you can pass the physical, perhaps the most tax-efficient investment will be to take the after-tax money and buy life insurance, which hugely leverages the assets that pass to your heir's income tax-free and your kids can “stretch” those assets with no requirements of withdrawal or taxation.

If you can’t pass the physical, or even if you can, consider gifting the after-tax money to your children to buy life insurance on their lives. There are specially-designed policies that will allow your children to receive income-tax-free money from those policies in their retirement years, as well as create a legacy asset for your grandchildren. 

Give this new info some thought.  It is contrary to what you’ve been taught for the last 50 years about retirement tax planning, and yet the new possibilities for leveraging your assets and reducing the tax impacts are many.

Benjamin Franklin said it best, “Nothing is certain except death and taxes,” but there’s no rule that says you can’t be smart about reducing taxes or that you need to pay more taxes than what’s legally required. Let’s brainstorm together about how this new way of thinking can benefit you and your family.  

Call me at 805-569-7666.