Don’t make the mistake of leaving your grandchildren with a tax bill instead of an inheritance
For older Americans, leaving retirement savings to their grandchildren without also leaving them a big tax bill is becoming harder under new rules that took effect in 2020.
Previously, heirs other than spouses had decades to draw down inherited retirement accounts. After the rules change, now they must do it within 10 years.
To maximize their family’s after-tax wealth, grandparents are changing their estate plans and creating new trusts. The timing change also has grandparents making a series of Roth conversions or big generation-skipping lifetime gifts.
These choices make sense with the amount of money and taxes that are at play. According to the Investment Company Institute, Americans held $12.5 trillion in IRAs as of March 31, 2023 and 52% of households headed by someone 65 or older have one.
By choosing to leave a Roth IRA, you avoid some of the problems of the accelerated tax hit from an inherited traditional IRA since those can cause a big tax bill, especially if distributions fall during the heir’s highest earning years. Minor grandchildren may also need to file a tax return to report the IRA payouts, and the income could be taxed at the parents’ rate.
However, because of the 10-year payout period, there is a risk that your heirs will spend the money quickly.
Other options to consider when planning your legacy is to start making lifetime gifts to grandchildren as soon as they are born. That can look like paying for diapers and preschool to setting up college 529 savings plans and special trusts to save estate and generation-skipping transfer taxes.
These strategies can be useful depending on how soon you want your heirs to benefit and how much you want to control how they spend the money.
If you’re worried about how your grandchildren or their partners might handle the inheritance, another option is to leave an IRA in a trust. In that case, a trustee would distribute the money based on the terms you set out in the trust.
Figuring out how to leave your inheritance to your grandchildren can be difficult, which is why it’s always helpful to work with a financial advisor. At Lineweaver Financial Group, we have a team of professionals at the ready to help coordinate all your financial needs and make sure we create a plan that works for your unique situation. Give us a call today. We’re here to help!
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