As an estate planning attorney, I have the unique opportunity to speak with clients every day at a variety of stages of their lives. Recently, many have been asking the same question about estate tax changes:
“Will the estate tax come back in 2020?”
We are living in the largest wealth transfer in history. An estimated $32 trillion will transfer from Baby Boomers to the next generation over the next 15 to 20 years. In addition, there is approximately $4.4 trillion held in retirement accounts that will transfer to the next generation.
The Current Status of the Estate Tax
On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act. As part of this overhaul of the tax code, the exemption from the federal estate tax became $11,180,000. In addition, a married couple was permitted under the new law to transfer $22,360,000 tax-free during their lifetime or at death. But this exemption is scheduled to “sunset” in 2025 and revert to Bush-era tax cuts of $5,400,000 (indexed for inflation).
In layman’s terms, this means is that if your estate is less than $11,180,000 (or $22,360,000 as a married couple), then your estate will not be subject to the estate tax. As a result of this law, less than 1% of Americans are subject to the estate tax.
However, in reviewing the upcoming wealth transfer, we must also look at the taxation of retirement accounts.
How Retirement Accounts Are Taxed
During one’s lifetime, a retirement account (whether that is a self-directed IRA, 401(k), 403(b), etc.) has the benefit of being pre-taxed. However, upon reaching a certain age (typically 70.5), one must begin drawing out of their retirement account and paying taxes on their withdrawals. This is referred to as a Required Minimum Distribution or RMD. When it is your retirement account, generally, the amount of your RMD will be based upon your life expectancy, which is set by the IRS.
What Happens When You Pass Away and You Have a Balance in Your Retirement Account?
If you have designated a surviving spouse as the account’s beneficiary, they may have the option to treat the IRA as their own. This special rule allows them to withdraw the RMD based upon their own life expectancy, subject to the IRS RMD tax tables.
A word of caution: this option may not be available based upon how your beneficiary designation is selected. If the beneficiary designation is named as the “Estate of” there is a high probability that your surviving spouse beneficiary will not be permitted to:
- Treat the IRA as their own
- Take the RMD over the course of their lifetime
- Enjoy the tax benefits that come with withdrawing an IRA over the course of their lifetime
What Happens When the Beneficiary is Not a Spouse?
This is a difficult question and can vary depending upon several circumstances. However, there are generally three options.
- A non-spouse beneficiary (such as an adult child) can withdraw the IRA all at once. However, the beneficiary will have to pay all the income taxes on that IRA.
- A non-spouse beneficiary can withdraw the entire balance over the course of five years. This is a better option, but there will be more taxes and less growth of the IRA than withdrawing the balance over the course of a lifetime.
- The most beneficial option is to withdraw the balance of the IRA over the course of one’s lifetime by taking an RMD. As discussed, this reduces the tax obligations as well as allows the IRA to grow over the course of one’s lifetime.
One important distinction: a non-spouse beneficiary of an IRA is not permitted to wait until age 70.5 when taking his or her RMD. The non-spouse beneficiary must take the RMD, generally, by December 31 of the year following the death of the IRA owner.
Taking an RMD as a non-spouse beneficiary over the course of your lifetime is much more beneficial than taking the balance at once or over five years. However, the days of being able to do so may soon be ending.
H.R. 1499 Passed the House of Representatives
On May 23, 2019, the U.S. House of Representative passed House Resolution 1499, commonly referred to as the SECURE Act.
Under the SECURE Act, a non-spouse beneficiary must withdraw the balance of an inherited IRA within 10 years instead of taking their RMDs over the course of their lifetime. This will drastically change how people plan their estates and how they pass their retirement account benefits to the next generation.
The almost unanimous passage of the SECURE Act by the House leads to the probability of the SECURE Act being passed in the Senate. If this occurs, this will be a major change to how Inherited IRAs are treated and will leave a lasting effect on the massive wealth transfer that will occur over the next two decades.
This is a good reason to meet with your estate planning attorney to discuss how this affects your planning.
Will there be Estate Tax Changes?
Nearly every Democratic candidate has proposed to reduce the current estate tax exemption from $11.18 million to $3.5 million and raise the top tax rate to 45%.
If there are estate tax changes, more estates will be subject to the tax. A reduction of the estate tax exemption (from $11.18 million to $3.5 million) will result in more families needing to update their estate plan to reduce their possible estate tax liability.
What Should you Do?
Overall, you should anticipate some amount of change to the taxation of Inherited IRAs and to estate tax changes, even if it is not capped at $3.5 million. With the increasing national debt (presently at $23 trillion), the government will likely be moved to the taxation of Inherited IRAs and a change to estate taxes.
If you have questions about estate planning, estate tax planning, and planning for the transfer of your retirement accounts, please contact our office at (513) 241-0400 or use the contact form available on this website to schedule a time to speak with one of our Estate Planning Attorneys.