In my last post I discussed Understanding Death and Taxes – Your Taxable Account . I also mentioned there was a big difference between investments inherited in a taxable account vs. an IRA or 401K account.
Currently if you bequeath investments held in a traditional IRA or 401K account your heirs will have to pay tax on the account(s). Currently the holdings are drawn down over a lengthy period of time and taxes areas this occurred, hence the term “Stretch IRA”.
If Congress kills the Stretch provision, your heirs would have to draw down the investments over 5 years and probably get hit by very large tax bills (drawdown plus their normal income). The Whitehouse tried to eliminate the Stretch in 2013 and again this year. Sooner or later this may get eliminated.
What might you do to anticipate leaving your heirs with a huge tax burden?
- Consider withdrawing money from your IRA to live on instead of the conventional wisdom of withdrawing from a taxable account. Maybe calculate out the amount that will still say keep you in the 25% tax bracket.
- Consider converting some of the IRA to a ROTH IRA (which is never taxed). Yes you again will pay taxes on the conversion but your heirs will pay less.
- Consider purchasing life insurance so that your heirs can use the proceeds to pay tax bills.