3 Replies Latest reply on Oct 12, 2010 8:03 PM by JerryD

    RMD's and Estate Planning

    charadrius
      I have long been aware that I will have required minimum distributions (RMDs) on my IRAs and work-related retirement accounts, but I never really delved into the effect of RMDs until yesterday.  My retirement plan has always been to live off the earnings of my investments and leave the principal to my children.  Now I realize that the RMDs throw a big monkey wrench into this plan; they force me to annuitize much of my retirement investments, and thus spend down the principal.  Obviously one thing I can do is convert as much as feasible to Roth IRAs, but beyond a certain level, that becomes too costly.  I was wondering if anyone here has investigated this situation and found any clever ways to leave more of the principal to their estate?

      Thanks.

      Thomas
        • Re: RMD's and Estate Planning
          JerryD
          I have done an extensive investigation of preserving retirement sheltered principle and continue to do so. I worked with a TIAA adviser and developed a spreadsheet of our entire portfolio, both retirement and taxable. My conclusion was to execute a long term strategy to move as much as possible to Roth's which are never taxable to you or your beneficiaries. Any funds in the Roth's are also beyond the RMD requirements.

          You don't say where you are in your retirement situation but I have been, and will continue to do so, moving IRA assets to the Roth's up until I reach 70.5 and encounter the RMD requirements. I have not completely thought through the complexities of doing so after RMD's start but I suspect that the tax consequences will be too high for me to continue. I have been converting funds for at least 5 years and have a number of years left to do so.

          You need to run the numbers for your situation, but I found that this strategy will move substantial funds out of the RMD situation and results in lower marginal taxes for a number of years after RMD's start due to a lower RMD. I am using taxable funds to pay the taxes on the conversions. Using a portion of the IRA's to pay the taxes may not be as advantageous.

          Look carefully at the marginal tax rates and your situation. With this long term strategy it is possible to convert large sums annually, $50-60k say, and still remain in a very low marginal rate, 15% say if retired with low income. But do NOT forget state taxes! I tried for a number of years to get the state to agree that these IRA -> Roth conversions are a taxable event which several state tax people denied. When I finally got a senior tax auditor who knew what he was talking about, I paid a pretty substantial tax on previous years. He was so amazed that I was so honest with him that he removed any interest and penalties for unpaid taxes from prior years. He thought that the state was really fortunate to even collect these past taxes. I have worked with auditors, but I rarely enjoyed the straightforward and fair treatment that I received from this gentleman.

          I strongly recommend that you investigate and understand the complex concept of "stretch IRA's". If you can convince your beneficiaries to take their mandatory distribution from both IRA's and Roth's over their IRS defined lifetime, the resulting growth can be incredible due to the extremely long investment period. If you can further convince them to use their mandatory distributions to fund sheltered accounts like their Roth's or increase their 401/403 contributions or place those funds into educational accounts for the grandkids, the result is generational sheltered funds that avoid IRS taxes for extreme periods or totally in the case of your Roth distributions to their Roth contributions.

          Some other special circumstances that I have used or discovered that enhance your Roth shelter are to utilize unused deductions on your annual tax bill (maybe the house is paid off and you can't even offset the standard deductions/credits) to finance the taxes due on these contributions and if you are ever in the circumstance where you have extra job related income to fund your Roth and your wife's with those funds (remember, both spouses do NOT have to work in order for the working spouse to fund their Roth). If you have some savings to pay any taxes, these points can be advantageous even when you are in the unfortunate situation where you are unemployed and possibly getting some part time income.

          If you would like to discuss more details outside of this public forum, you could send me an email using my profile and we could drill down deeper.

          Besides preserving retirement funds for the kids, I view Roth's as emergency, non-taxable assets that could be used by the spouse or to fund unexpected situations that might get expensive should I need to take those funds from the IRA's.
            • Re: RMD's and Estate Planning
              charadrius
              Jerry,

              Thanks for the thoughtful reply.  I have considered Roth conversions, but I am hesitant to convert more than a small amount for the following reasons: I live in a state with relatively high income taxes, but I am considering retiring to a state that has no income taxes.  Since the state I live in definitely includes Roth conversions as part of it's taxable income, I run the risk of paying higher state taxes now, but not getting any additional benefit for this after I retire.  Further, the state I live in has a fairly generous property tax refund program for low and middle income residents.  Conversion amounts go into the formula for this program and can a significant decrease in the property tax refund.  Again, if I move, I might get no benefit in the future that makes up for this lose of revenue now.

              Since writing my original post, I have worked through a few different scenarios of the effect of RMDs on my estate.  I have found that the situation is not as bad as I originally thought.  In most scenarios, we would still have about 1/2 of the principal of our IRAs and other pre-tax retirement accounts, even if I or my wife live to our mid-90s.  I figure when the RMDs are really high, I will give some of the money to my kids, maybe allowing them to maximize their Roth IRAs.  I will have to pay taxes on this (and it will increase the taxable amount of my social security benefit), but on the whole the financial implications aren't too different from doing Roth conversions now.

              Thomas
                • Re: RMD's and Estate Planning
                  JerryD
                  Thomas, I'm glad that you looked at the state side of this. Many would miss it and get an unwanted surprise. Just be sure that you understand the details. For instance, in Arkansas, each spouse is entitled to a $6,000 exemption for any retirement income, including IRA -> Roth conversions. Each state has some pretty quirky exceptions that may be opportunities.



                  I also commend you on looking at the real estate taxes you might encounter. Again, AR freezes the property evaluation when one spouse reaches 65. Your state may have a quirk in this area too.



                  Again, I do not understand where you are at in your retirement process or at what age you intend to make the move, but let's just say that you do it at 62, then you could investigate my strategy versus your state tax situation for conversions from 62 through 69 - still a lot of money at $50-60k per year. I can't emphasize enough how important using a stretched IRA (Roth) can have on your kids and grandkids financial future.



                  Thomas, you imply that once the RMD is made that it disappears. However, if you don't need all of the money to live on you can still pay the taxes on it and put the excess into a TIAA annuity which has some sheltered and stretch properties.



                  Thomas, the offer still stands if you want to drill down a bit off line. Just recognize that I am NOT a tax or financial adviser but I have done some foot work that may apply.



                  Good luck!



                  Jerry