Withdrawals from an Estate and Tax Planning Perspective

Families often ask us how best to fund their obligations or monthly cash flow from their various account types. When making this decision, it’s best to revisit your goals and consider the tax and estate planning implications.

Tax Perspective

Withdrawals from taxable and after-tax retirement accounts like a Roth IRA can be made tax-free, or by paying less tax than a withdrawal from a pre-tax retirement account taxed at your ordinary income tax rates. This leads to less tax owed now.

Inheritance Perspective

For a beneficiary, it’s most advantageous to inherit taxable and after-tax retirement accounts, such as a Roth IRA. Beneficiaries receive more after-tax dollars than if they inherited a pre-tax IRA because of the step-up in basis, which eliminates capital gains in the taxable account, and because withdrawals from the inherited Roth IRA are tax free.

Since required minimum distributions (RMDs) for inherited IRAs are based upon the life expectancy of the beneficiary, you can effectively stretch the life of your retirement assets much longer by selecting a younger beneficiary. This means it may make more sense to make your grandchildren your beneficiaries in some circumstances, rather than your children, to extend the life of the assets.

Charitable Giving Perspective

Donating pre-tax retirement assets to charity is the most advantageous because beneficiaries receive 100% of the assets versus having to pay ordinary income tax on distributions.

After you reach age 70 ½, you can also give up to $100,000 of your RMD tax-free to any number of qualified charities by completing a qualified charitable distribution (QCD).

Case study

Bill and Susan Smith recently retired from long careers. Their investable net worth is $3 million. Assets include:

• $1,000,000 individual taxable account
• $1,500,000 rollover IRA
• $500,000 Roth IRA

The Smiths have two adult children who are independent and nearing the stage of starting families of their own. Outside of account withdrawals to replace their income, the Smiths will receive Social Security and a small pension to fund their $150,000 a year spending rate.

The Smiths want to live fully in retirement, but also want to leave as much to their children and to charity as possible.

The Smiths should keep the following in mind when making withdrawals:

• Tax perspective: Withdrawals from their Roth IRA and individual taxable account would lead to the least amount of taxes paid now. As a result, their RMDs from their pre-tax rollover IRA may become larger in future years.
• Inheritance perspective: Withdrawals from their pre-tax rollover IRA now would leave more of the advantageous Roth IRA and individual taxable account to their children.
• Charitable giving perspective: The Smiths could leave part or all their remaining pre-tax rollover IRA to charity and have the charity receive 100% of the value. Furthermore, if they want to give while still alive and have reached age 70 ½, they could give to a qualified charity through a QCD.

While there isn’t a one-size-fits-all solution for all families, it’s important to consider the implications each account type has on your estate and tax planning goals and objectives.

Please download our guide on “What Account Should I Withdraw from After I Retire?” for more insight into this decision-making process.

Contact Merriman to speak with an advisor about how best to plan for your withdrawals or for any of your other planning needs.