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    Death Taxes and the Stretch IRA

    Dying is expensive.  Despite this year’s $5.43 million federal estate-tax exclusion, many heirs will still face steep tax bills mostly because of the income taxes due on inherited retirement accounts.  

    If you pass on a stock in a regular taxable account that has climbed in value, the cost of the investment for tax purposes automatically rises to its current value at your death.  This “step-up” means that the potential capital-gains tax bill can disappear.  But if you die owning traditional retirement accounts (e.g., 401(k)) and individual IRAs, the income taxes owed on withdrawals still have to be paid by your heirs.  

    Currently, beneficiaries can draw down the account slowly over their lifetimes, and this “stretch” minimizes the tax burden.  But what if Congress kills off this stretch?  Your heirs may be forced to empty inherited retirement accounts within five years of your death, and the extra income could push them into much higher tax brackets.  The White House proposed eliminating the stretch IRA in 2013, and many experts believe it is just a matter of time until the law gets changed.  That’s bad news for investors.

    So what are Americans to do?  There are several strategies to discuss with your accountant and financial advisor:

    1.  Turn traditional advice on its ear and hang on to taxable-account investments with a view to getting the step-up in cost basis upon your death.  Pull money out of your IRA now to cover your current living expenses (rather than spending down your taxable-account assets).  Do this strategically and only under advisement.  The last thing you want to do is push yourself into a higher tax bracket.

    2. Convert part of your traditional retirement accounts into a Roth IRA.  You will have to pay income tax on the conversion, but it will grow tax-free after that.  If the tax you will pay on conversion is less than your beneficiaries will pay when they empty the account, then doing this makes sense.

    3. Donate.  If you were planning on donating to charity upon your death, leave the IRA money to the charity and taxable-account money to your heirs.

    4. Purchase a life insurance policy so your heirs will have money to pay your IRA (and estate) taxes.  Life-insurance   proceeds should be income-tax and estate-tax free if you arrange for someone else to own the policy.  We suggest your children or an irrevocable trust.

    5.  If the stretch IRA disappears, it may makes sense to leave your IRA to a charitable remainder trust.  This involves some high fees but will allow your heirs to enjoy a lifetime of withdrawals from the IRA.

    Again, discuss these solutions with your accountant and financial advisor.  These suggestions are not prescriptions for your specific situation but could be helpful as you plan for the future.  For most Americans approaching retirement age, retirement accounts are the second largest asset they own, after their homes.  You worked hard for that money.  Don’t give it away in taxes.

     

     

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