I have had several clients pass away in the last 12 months and all with different “types” of beneficiaries, e.g. spouse, family trust, children, siblings, with varying degrees of planning efficiencies in distributing the client’s wealth. Poor planning or failure to update one’s intentions can and may lead to an unexpected outcome, i.e. ask the IRS. There is never a bad time to ensure the client’s assets are reviewed for the most efficient tax transfer and aligned with their objectives. The SECURE Act changed the retirement and estate-planning landscape and you need to be aware of the tax efficiencies available whether you are a surviving spouse or not.
I will first address Qualified IRAs. To qualify as an eligible designated beneficiary, the IRA must designate a specifically named beneficiary. Eligible designated beneficiaries may use the pre-SECURE-Act rules for RMDs, and stretch distributions based on the beneficiary’s life expectancy. The surviving spouse so long as s/he is not 10 years younger may either stretch the IRA or commingle with a personal IRA. On the other hand, the surviving spouse can designate the IRA as their own by rolling it over or transferring it to the surviving spouse’s existing IRA or to a new IRA account in their name. The latter is not a stretch IRA but sometimes called a fresh start IRA since the RMD schedule is determined solely by the surviving spouse’s age.
With a stretch IRA for a surviving spouse, s/he can assume a beneficiary status rather than treat the IRA as their own. Assuming the original owner had not reached RMD age, RMDs are then calculated on the surviving spouse’s life expectancy. A Stretch IRA is a strategy to lengthen the IRA’s tax deferral by withdrawing only the RMDs for a period based on life expectancy. The Stretch provision provides significant tax savings to the beneficiary, allowing them to spread the income over a longer number of tax years, minimize the tax rates applied to the income and allow the account to grow tax deferred. Non spouse ineligible designated beneficiaries must distribute the proceeds and/or pay taxes on the assets within 10 years. Being “ineligible” typically simply means not being a spouse, so you have less options but still many you may not have been aware of. The 10-year rule applies to both traditional IRAs and Roth IRAs.
Many factors apply to determine which withdrawal strategy within the 10-year period should be selected. Considerations like age, whether still working, tax bracket, financial need, amd how close one is to retirement will impact the decision in selecting the best schedule for withdrawals for that recipient: Take the entire account balance immediately; delay any payments till the end of the distribution period; take withdrawals over the 10-year period; determine whether RMDs must be taken based on the required beginning date for RMDs for the deceased Owner; or even consider a partial or full tax conversion to a Non-Qualified contract!
Addressing inherited non qualified funds has separate rules but some of the identical considerations apply.
Rather than taking a distribution as a lump sum or over a five-year period, the non qualified stretch allows the beneficiary to meet IRS distribution requirements. They can take distributions over a period equal to their life expectancy, which spreads out the taxes due on the gains over their lifetime. There is no 10-year limitation. (Note in a rare circumstance a much older beneficiary’s life expectancy could be less than 10 years.) This is a big deal and should be seriously taken into account. This increased flexibility reduces an immediate tax burden. A distribution must be received every year that is based on the beneficiary’s life expectancy factor but a real nice feature is that the beneficiary can access more of the monies if they need it. The taxation of the withdrawals will be taxed on a LIFO basis (last-in, first-out) before the cost basis is returned. If there are no gains in the contract, then all withdrawals are not taxed at all.
Clients who leave money to their beneficiaries do create a lasting legacy to be remembered by the current beneficiaries and those progeny after.
There is never a better time than the present to sit with a client to discuss who their assets should pass to, clean up account beneficiary designations and assess whether your designations and plans are aligned. Based on my experience, failing to review this “unpleasant” topic (which can be extremely challenging) can result in some loved ones feeling slighted and affect lifetime relationships long after your client passes. Unfortunately, I have witnessed some clients’ families becoming estranged over the amount they received and when it is distributed. The last regret in life the client would ever have imagined.
Sometimes the most difficult step is having your client discuss his/her plans with the key beneficiaries while alive. The client may simply feel that s/he is not capable of doing so because of certain family dynamics. “They’ll figure it out” is not planning and may result in making the IRS your richest beneficiary. Naturally, your client is entitled to not deal with a potential emotional, stressful discussion. Understood.
Poor financial decision making or procrastination, however, may be an early indicator of frontotemporal dementia. Some with this condition might trust someone they would not normally trust, lead to becoming withdrawn, become less agreeable or on the contrary become less trustworthy, become more disorganized or have increased difficulty completing tasks. At least educating the client and potentially their closest loved one(s) with the available strategies currently permitted under the law should lead to a clearer understanding of their objectives and feelings and lessen the chances of a lifetime of success not being appreciated. Not an easy task for the financial advisor but a far harder one for the client, so everyone needs to proceed diligently and cautiously.
(See My Long Term Care Story As An Advisor, Broker World 10/2021, and Should I Add Annuities To My Retirement Plan Or Not?, Broker World 10/2023.)
