By Jeremy A. Wechsler, Esq.
Investment Advisor Representative
[email protected]
The term “tax bomb” is not new, and it’s often used to describe what some retirees can face if they don’t plan properly. But one of the biggest tax bombs we see today doesn’t happen during retirement… it happens after someone passes away.
For years, retirees were told to maximize their traditional IRAs and 401(k)s — and for good reason. Those accounts provided tax deductions and decades of tax-deferred growth. But under today’s rules, large retirement accounts can create major tax problems for the next generation.
Under current law, most non-spouse beneficiaries who inherit an IRA must fully withdraw the account within 10 years. Years ago, many beneficiaries could “stretch” those distributions over their lifetime and potentially see tremendous tax and growth benefits as a result. That strategy is largely gone.
Now imagine a child or loved one inheriting a significant IRA while they’re in their peak earning years. They may already have a strong salary, bonuses, stock compensation, or business income — and now they’re forced to pull large taxable distributions from the inherited IRA on top of it.
That can mean:
- Higher federal and state income taxes
- Larger Medicare premiums
- Increased taxation of investment income
- Less flexibility for their own retirement planning
In some cases, families can lose hundreds of thousands of dollars unnecessarily to taxes over time.
This is where estate planning and investment planning really begin to overlap. A lot of people think estate planning simply means having a will or trust prepared. Those documents are important — but they are only part of the picture. The investment and tax side matters just as much.
For example:
- Should portions of a traditional IRA be converted to a Roth IRA over time, particularly during lower-income retirement years?
- Are beneficiaries properly coordinated with the estate plan?
- Does it make sense to leave taxable accounts to children instead of large pre-tax IRAs, given the potential step-up in basis? This becomes especially important when charitable giving is part of the plan — being strategic here can make a significant difference.
- Are trusts named as beneficiaries that may unintentionally create even higher compressed trust tax rates?
- Would life insurance help ease the tax burden for heirs inheriting large tax-deferred accounts? (And yes — life insurance proceeds are generally income tax-free.)
These decisions can have enormous long-term consequences for a family.
Even families nowhere near the federal estate tax exemption may still face significant tax issues involving inherited retirement accounts, income taxes, and capital gains. Frankly, for many families today, income taxes are the bigger concern.
There is a major difference between planning for asset accumulation and planning for asset preservation and transfer. A good retirement plan coordinates investments, taxes, and estate planning together — because each piece affects the others.
That’s what we call the retirement maze, and that’s where an experienced advisor can make a real difference.
We will continue to keep you updated as tax laws evolve and change, and help you make the most strategic decisions possible — both for your retirement and for the next generation.