Paul O. Dillon, Attorney at Law

Estate Planning Questions for Couples with a Big Age Gap

Even if it was never an issue in the past, when couples with a significant age gap reach their 60s and 70s, the age difference can present challenges. When one partner is ten or more years younger than the other, assets need to last longer, and the impact of poor planning or mistakes can be far more complex. The article in Barron’s “Big Age Gap With Your Spouse? What You Need to Know” explains several vital issues.

Examine healthcare coverage and income needs. Health insurance can become a significant issue, especially if one partner is old enough for Medicare and the other does not yet qualify. How will the couple ensure health insurance if the older partner retires and the younger depends on the older partner for healthcare? The younger partner must buy independent healthcare coverage, which can be a budget-buster.

Be strategic about Social Security. Experts advise having the older spouse delay taking Social Security benefits if they are the higher-income partner. If the older spouse passes, the younger spouse can get the bigger of the two Social Security benefits. Delaying benefits means the benefits will be higher.

Planning for RMDs—Required Minimum Distributions. Roth conversions may be a great option for couples with a significant age gap. Large traditional tax-deferred individual IRAs come with large RMDs. When one spouse dies, the surviving spouse is taxed as a single person, which means they’ll hit high tax brackets sooner. However, if the couple converted their IRAs to Roths, the surviving spouse could withdraw without taxes.

Estate planning becomes trickier with a significant age gap, especially if the spouses have been married before. Provisions in their estate plan need to be made for both the surviving spouse and children from prior marriages. An estate planning attorney should be consulted to discuss how trusts can protect the surviving spouse, so no one is disinherited. Beneficiary accounts also need to be checked for beneficiary designations.

Couples with a significant age gap need to address their own mortality. A younger partner who is financially dependent on an older partner needs to be involved in estate and finance planning, so they know what assets and debts exist. Life has a way of throwing curve balls, so both partners need to be prepared for incapacity and death.

Plans should be reviewed more often than for couples in the same generation. A lot can happen in six months, especially if one or both partners have health issues.

Reference: Barron’s (May 19, 2024) “Big Age Gap With Your Spouse? What You Need to Know.”

Estate Planning for a Taxing Inheritance

Estate planning should address tax planning to accomplish several goals. In addition to minimizing tax liability, tax-sensitive estate planning can ensure family members inheriting wealth are given a helpful asset, not a costly one. A recent article, “Inheriting Tax Liabilities” from Financial Advisor, explains how this can be done.

A beneficiary inheriting a pre-tax traditional IRA has to pay full state and federal income tax on any withdrawals, which must occur within ten years. Demographics show this inheritance most often occurs when the heirs are in their careers' highest tax income bracket, making it a double tax whammy.

There’s no step-up in basis for a traditional IRA. A $3 million IRA isn’t a $3 million IRA when it’s inherited. If the person inheriting the IRA is in a high-tax state and is also a high-income earner, they could lose nearly 45% every year when taking their required distributions.

The timeframe for IRA inheritances is tricky. Let’s say a couple works hard and saves in their tax-deferred 401(k) for three decades. When they retire, they roll those savings into traditional IRAs. When the second spouse dies, her children will probably be 55 to 60 years old, when people are usually in their highest earning and taxable years.

Another hitch: inherited IRA distributions can’t be donated to charity or kept in the IRA to be passed along to the heir’s children.

How to address this? It depends.

If there are two adult children and one has more modest wages and resides in a low-tax state, giving the lower-income heir a larger percentage of the IRA will result in a larger after-tax amount. If the other child is a high-income earner, bequeathing after-tax assets may make more sense. The two heirs may end up with the same amount when adjustments are made to their circumstances.

In some instances, it makes sense for the parents to convert traditional IRAs to Roth IRAs and pay the taxes to give heirs the advantages of the Roth IRA. Another strategy is to bequest pre-tax IRA assets to a charity and give heirs tax-free assets.

Think less about equal inheritances and more about adjusting assets to end up with the same spendable savings.

The same adjustments will be helpful when planning for illiquid assets like the family home. Preparing assets like real estate or art collections requires time, and the cost of commissions and marketing can reduce the inheritable value of the assets.

An inheritance is a gift to loved ones, improved by clear-sighted estate planning that considers the individual family’s circumstances in more depth. Review your family’s entire picture with your estate planning attorney so the end results will truly be what you wish.

Reference: Financial Advisor (March 15, 2024) “Inheriting Tax Liabilities”

What’s the Age Cut-Off for a Roth IRA?

Roth IRAs aren’t just for young people, as long as you meet the criteria regarding income, how much you may contribute and when you’re eligible for penalty-free withdrawals. A recent article, “Are You Too Old to Benefit From a Roth IRA?” from U.S. News & World Report, explains the benefits and requirements for older workers considering a Roth IRA.

Requirements for a Roth IRA

Once you meet the qualifications, you can add funds to a Roth IRA at any age. In 2024, the contribution limit Is $7,000 or $8,000 if you’re 50 or older. The account must be open for at least five years to take penalty-free withdrawals in retirement. If you take funds out early, you could face penalties, and contributions to a Roth IRA may only be made from earned income.

A single person may add funds to a Roth IRA if they earn up to $146,000. After that, the amount you may contribute is phased out until income reaches $161,000, after which you can’t add funds directly to the account. For married couples, the income threshold is less than $230,000.

Roth IRA Tax Benefits

Funds are taxed before they go into a Roth IRA account, giving the advantage of the account the tax-free distributions of contributions and earnings. In addition to the five-year rule, you’ll need to meet these eligibility requirements:

• The original owner dies, and you inherit the Roth IRA.
• The owner is at least 59 ½ years old.
• The owner meets disability requirements.
• The distribution is used for first-time homeowner expenses of up to $10,000.

Age Considerations

If you’re in your 70s and still working, there are some facts to consider before opening a Roth IRA. The tax-free growth of Roth IRAs works best as the holding period increases. The up-front tax costs may be very high if you’re in your highest income level and a higher tax bracket. This makes a Roth IRA more advantageous for younger contributors. However, if you work part-time, your lower taxable income might make the Roth IRA an excellent way to save.

Passing Funds to Heirs

With traditional IRAs or 401(k)s, Required Minimum Distributions start at a certain age, usually after celebrating your 73^rd birthday. However, there are no RMDs for Roth IRAs, and the funds remaining in the account after you die could be passed on tax-free. Beneficiaries may inherit the Roth IRA while allowing it to grow tax-deferred for up to ten years, then take the money without paying taxes.

Opening a Roth IRA later in life should be coordinated with your overall retirement and estate plan to be sure it works in concert with your overall estate plan. When reviewing your estate plan, it’s something to discuss with your estate planning attorney.

Reference: U.S. News & World Report (Dec. 29, 2023) “Are You Too Old to Benefit From a Roth IRA?”

Can Grandparents Give Money to Grandchildren for College?

Helping grandchildren prepare for long-term success and easing the financial burden of college costs is a gift for two generations, as mentioned in a recent article from Kiplinger, titled “529 Plans: Give the Gift of Education (and Compounding).”

Giving cash directly to children or parents isn’t the best long-term strategy. Once the money is given, control is surrendered, and the gift may not be used as intended by the giver. Saving for college is one of the significant financial challenges parents face, especially considering the high inflation of college tuition costs. Between 2021 and 2022, U.S. college tuition rates increased by 12%.

This is where estate planning intersects with the new year. As the current historically high estate tax exemption ends at the end of 2025, managing the size of one’s estate becomes a higher priority. The structure of 529 college savings accounts can be used for tax efficiency and to control the eventual use of the gift while taking advantage of long-term compounding.

Current gift tax rules allow individuals to gift up to $18,000 per year per person. Therefore, a married couple could gift $36,000 to each child and grandchild without it counting against their lifetime exemption or requiring them to file a gift tax return. However, the 529 is even more advantageous, allowing a five-year front-loading of such gifts per recipient.

If your state has a plan, funding 529 plans offers deductions on state income taxes. If your state doesn’t have a 529 plan, you can open an account in another state but won’t receive the tax deduction.

There have always been concerns about overfunding a 529 account or having unused funds if the beneficiary decides not to attend college. Most plans allow account owners to change beneficiaries without any tax consequences as long as the new beneficiary is a member of the current beneficiary’s family. If the new beneficiary is younger than the prior one, it may be wise to change the asset allocation to reflect the new time horizon.

Another common question regards the impact gifting may have on the student’s application for federal aid. While 529 plans owned by parents are considered, 529 plans owned by grandparents are not on the FAFSA (Free Application for Federal Student Aid) form.

Changes to the original 529 structure have rendered these accounts even more valuable. The Tax Cuts and Jobs Act expanded the eligibility of 529 accounts for private and parochial K-12 schools. Then, the SECURE Act allowed 529 funds to be used to pay down up to $10,000 in student debt.

Starting in 2024, the SECURE 2.0 Act allows 529 funds to be rolled over into a Roth IRA at the annual contribution limit up to a lifetime maximum of $35,000 for a beneficiary. The account needs to be open for at least 15 years. Still, having an account grow in a tax-free environment and removing the distribution restrictions presents a valuable new investment tool.

Speak with your estate planning attorney about how to incorporate the benefits of the 529 account into your estate plan to help family members achieve educational goals and plan for estate taxes.

Reference: Kiplinger (Dec. 20, 2023) “529 Plans: Give the Gift of Education (and Compounding)”

Should You Gift Kids Inheritance Now, or After You’ve Passed?

This is a genuine dilemma facing millions of parents and grandparents as they prepare to pass an enormous amount of wealth—$73 trillion—to the next generation. There are pros and cons to both approaches, according to the article, “Give the Kids Their Inheritance Now or Make Them Wait? 3 Things to Keep in Mind,” from Barron’s.

Giving too much too early could put parents in an economic bind in their later years. Therefore, this needs to be considered in light of today’s longer life spans. However, if you can afford to make a generous gift and your children could use the money now for a good purpose, it’s hard to justify making them wait.

How much to give is as critical as when to make the gift. The predominant concern is if you give your children too much, they won’t be motivated to earn their own wealth, or other family members will resent the gift. Estate planning attorneys and financial advisors routinely speak with families about these issues. These conversations always consider the values they want to instill in their children.

In some cases, parental support can help a child while working at an entry-level (i.e., low paying) job in their dream career. Covering the cost of rent for a few years can offer young adults a support net until they achieve financial stability.

This is very different than paying the expenses of a young adult with no career goal whose primary focus is a robust social life.

Anyone can make a yearly gift to any other person of up to $17,000 tax-free, or $34,000 per couple, but there are ways to make gifts without triggering gift taxes. Direct tuition payments to schools are tax-free. Unlike putting money into a 529 account, there is no limit to how much can be paid directly to a college or university. Parents and grandparents could also help with a downpayment on a child’s home without paying gift taxes.

Gifts don’t have to be large to have an impact. Some parents and grandparents give their children or grandchildren a small amount to start saving for retirement. A gift of a few thousand dollars during their 20s can grow into a nice sum over many decades. If the recipient has earned income, you can contribute to their IRA or Roth IRA accounts.

If assets are limited, consider giving personal possessions, such as jewelry or family heirlooms, to younger generations. You’ll get to see them enjoy their gifts, without putting your own financial situation at risk.

Whenever the decision is made to make these gifts, families should talk about their values and intentions around money.

If there are concerns about children losing an incentive to work because of the family’s wealth, a spendthrift trust might pass wealth along while controlling its distribution.

Remember that today’s generous federal estate tax rules are set to expire in 2026. Currently, individuals can gift up to about $13 million ($26 million for couples) tax-free in their estate plans. If the exemptions expire, this amount will be cut by approximately half.

Reference: Barron’s (Nov. 4, 2023) “Give the Kids Their Inheritance Now or Make Them Wait? 3 Things to Keep in Mind”

A Roth Conversion Can Benefit Retirement Plan

Before 2020, leaving a traditional IRA to younger beneficiaries created dual tax breaks. The original owner reduced taxable income by making pretax contributions during their lifetime, and beneficiaries could stretch the benefits of tax deferral over their lifetime. All that ended with the SECURE Act, but there are some options, as explained in the article “Why a Roth Conversion is a Powerful Estate Planning Tool” from Think Advisor.

After the SECURE Act, beneficiaries who don’t qualify as “eligible designated beneficiaries” or EDBs must empty the inherited IRA account within ten years. If the original owner had already begun taking minimum required distributions, the beneficiary must also take annual RMDs during the ten-year distribution period.

Someone who inherits a traditional IRA must now pay taxes on the entire account balance within ten years of the original account owner’s death. This can be a sizable tax burden, especially if the beneficiary is in their peak earning years.

Roth beneficiaries who don’t qualify as EBDs must empty the account within the same ten-year distribution period applying to traditional IRA accounts. However, Roths have a decisive advantage during the original owner’s lifetime: no RMD rules.

The original owner will always be deemed to have died before their required beginning date because a Roth account can never go into pay status since there is no required beginning date for distributions. Therefore, the Roth IRA beneficiary can wait until the tenth year to empty the account, allowing the funds to grow tax-free without worrying about the tax hit in Year 10.

When the beneficiary eventually takes distributions, the original contributions are nontaxable because the original owner paid taxes on Roth contributions during their lifetime. If the five-year rule is satisfied—at least five years have passed since the original owner made their first contribution or conversion to the account—earnings will also be tax and penalty-free to beneficiaries.

Roth accounts benefit the original owner because they offer a tax-free source of income during retirement. However, they’re also a valuable tax-free gift for account beneficiaries.

Reference: Think Advisor (Sep. 1, 2023) “Why a Roth Conversion is a Powerful Estate Planning Tool”

The Future of Your IRA and How the SECURE Act Changed the Rules

An ongoing series of changes from Congress has estate planning lawyers paying close attention to what’s going on in Washington. The IRS recently proposed more changes to IRAs, details of which are explained in this recent article “The Secure Act Changed Inherited IRA Rules. What’s an Advisor to Do?” from Think Advisor. Every time the laws change, new opportunities and new restrictions are presented.

Having to empty inherited IRAs within 10 years makes the IRA less attractive from an estate planning perspective. If your legacy plan included leaving significant assets through an IRA, there are a number of alternatives to consider. First, take a longer look at your estate through an estate planning, inheritance and tax planning lens. Do you have enough funds to pay for the retirement you planned without the IRA? If not, the next steps may not apply to your situation.

What are your estate planning goals? If married, your spouse is probably the beneficiary on retirement accounts and life insurance policies. If you don’t know who is named as your intended beneficiary, now is the time to check to be sure your beneficiaries are up to date.

Taxes come next, for you, your spouse and any non-spousal heirs. Withdrawals from traditional Roth IRAs are not generally taxable. Will anyone (besides your spouse) receiving the IRA be able to pay the taxes, or will they need to use the assets in the IRA to pay taxes?

The Roth IRA provides an excellent alternative to getting hurt by the SECURE Act’s 10-year restriction on inherited IRAs. Taxes are paid when the account is funded, there are no withdrawal requirements and the accounts are free to grow over any length of time. Money in a traditional IRA may be converted to a Roth IRA, although you will be paying taxes on the conversion.

The Roth IRA conversion has a five-year requirement. Funds must be converted and remain in the account for five years before the more flexible Roth rules apply.

Roth IRAs may be passed to beneficiaries income-tax free. Non-spousal beneficiaries can take withdrawals from Roth IRAs tax-free as long as the five-year rule has been met. The beneficiaries can then use their inheritance as they wish, without the funds being diminished by higher taxes resulting from taking out large sums in a relatively short amount of time.

Roth IRAs are not exempt from federal estate taxes; just as traditional IRAs are not exempt. By making the conversion and paying the taxes upfront, however, you can at least minimize income taxes for heirs, even though you can’t eliminate the federal estate tax.

Rather than do the conversion all at once, consider doing a Roth IRA conversion over time, figuring out with your estate planning attorney the best way to do this to minimize your tax burden and adjust it for years when income is lower.

This flexible strategy with Roth IRAs can be used with all or a portion of the IRA, protecting part of the IRA for the next generation while using part of the funds for retirement. Your estate planning attorney will help you determine the best way to go forward, to meet your current and future needs.

Reference: Think Advisor (June 21, 2022) “The Secure Act Changed Inherited IRA Rules. What’s an Advisor to Do?”

What Happens Financially when a Spouse Dies?

Losing a beloved spouse is one of the most stressful events in life, so it’s one we tend not to talk about. However, planning for life after the passing of a spouse needs to be done, as it is an eventuality. According to a recent article from AARP Magazine, “The Financial Penalty of Losing Your Spouse,” the best time to plan for this is before your spouse dies.

You’ll have the most options while your spouse is still living. Estate plans, wills, trusts, and beneficiary designations can still be updated, as long as your spouse has legal capacity. You can make sure you’ll still have access to savings, retirement, and investment accounts. Create a list of assets, including information needed to access digital accounts.

Make sure that your credit cards will be available. Many surviving spouses only learn after a death whether credit cards are in the spouse’s name or their own name.

Get help from professionals. Review your new status with your estate planning attorney, CPA and financial advisor. This includes which accounts need to be moved and which need to be renamed. Can you afford to maintain your home? An experienced professional who works regularly with widows or widowers can provide help, if you are open to asking.

A warning note: Be careful about new “friends.” Widows are key targets of scammers, and thieves are very good at scamming vulnerable people.

Be strategic about Social Security. If both partners were drawing benefits, the surviving spouse may elect the higher benefit going forward. If you haven’t claimed yet, you have options. You can take either a survivor’s benefit based on your spouse’s work history, or the retirement benefit based on your own work history. You will be able to switch to the higher benefit, if it ends up being higher, later on.

Be careful about your spouse’s 401(k) and IRA. If you’re in your 50s, you are allowed to roll your spouse’s 401(k) or IRA into your own account. However, don’t rush to move the 401(k). You can make a withdrawal from a late spouse’s 401(k) without penalty. However, it will be taxable as ordinary income. If you move the 401(k) to a rollover IRA, you’ll have to pay taxes plus a 10% penalty on any withdrawals taken from the IRA before you reach 59 ½. Your estate planning attorney can help with these accounts.

Use any advantages available to you. The IRS will still let you file jointly in the year of your spouse’s death. Tax rates are better for married filers than for singles. Any taxable withdrawals you’ll need to take from 401(k)s or IRAs may be taxed at a lower rate during this year. You may decide to use the money to create a rollover Roth IRA or to put some funds into a non-tax deferred account.

Don’t rush to do anything you don’t have to do. Selling your home, writing large checks to children, or moving are all things you should not do right now. Decisions made in the fog of grief are often regretted later on. Take your time to mourn, adjust to your admittedly unwanted new life and give yourself time for this major adjustment.

Reference: AARP Magazine (May 13, 2022) “The Financial Penalty of Losing Your Spouse”

Can I Pay Less Taxes on My Retirement Funds?

No one likes paying taxes on retirement funds. However, unless you have a Roth IRA or SEP, funded with after-tax dollars, you will owe taxes on withdrawals. However, according to a recent article from U.S. News & World Report, “How to Pay Less Tax on Retirement Account Withdrawals,” there are strategies to reduce taxes on your retirement account withdrawals.

Avoid the early withdrawal penalty. If you take money from a traditional IRA before age 59½, the penalty is 10% plus the income tax due on the withdrawal. If you are in a pinch and need the funds, you would be better off taking withdrawals from a 401(k), which is penalty free if you leave the job associated with the 401(k) at age 55 or later. You might be able to avoid the penalty if the money is needed for a large medical bill, college costs or a first home purchase.

Roll over a 401(k) without tax withholding. Changing jobs? If you take money from a 401(k) when you change jobs, 20% is held for income tax. If you do not put the entire distribution directly into a new retirement account, you could end up owing income tax and the early withdrawal penalty. One way to avoid the tax withholding and penalties is to do a direct transfer from your 401(k) to the trustee of another 401(k) or IRA. Trustee-to-trustee transfers are not generally considered a taxable event.

Manage your required minimum distributions. IRA and traditional 401(k) owners are required to take minimum distributions after age 72. Missing an RMD is expensive: the penalty is 50% of the amount you should have withdrawn, plus income taxes. However, if you are still working after age 72 and do not own 5% or more of the company you work for, you can keep delaying those RMDs from a 401(k) account held for you by your employer until you retire. For IRAs, you still have to take those withdrawals.

Be careful about distributions. Plan the distributions for the first year. You do not want to take two distributions and risk getting bumped into a higher tax bracket. The first RMD needs to be taken by April 1 of the year you turn 72 (or 70½ if you were born before July 1, 1949). The second and all subsequent distributions are taken by December 31 each year. If you delay the first distribution until April, you will end up taking two distributions, which could lead to a big tax bill.

Taking withdrawals earlier than age 72. By taking traditional retirement account withdrawals during your 60s, you can spread the tax bill over more years and enjoy the benefits of a lower tax bracket, reducing your overall lifetime tax bill. Try to take 401(k) or IRA withdrawals during a year when your income is low, like after you retire but before you take Social Security benefits.

Consider a qualified charitable distribution made directly from your IRA. Retirees 70½ or older can avoid income taxes on IRA withdrawals of up to $100,000 (or $200,000 per couple), if they make a QCD directly from their IRA to a qualifying charity. You can also donate part of your RMD and withdraw the rest of income.

Keep tax-preferred investments out of retirement accounts. If you have investments generating long-term capital gains in a retirement account, you will pay a typically higher regular income tax rate when you take the funds from the account. By contrast, you can lower the taxes by holding more highly tax investments (like Treasury inflation-protected securities, corporate and government bonds and funds generating short-term capital gains) within retirement accounts.

Balance retirement funds taxes with your overall retirement plan to try to minimize taxes. Do not neglect to discuss tax planning when you sit down with your estate planning attorney to create or revise your estate plan.

Reference: U.S. News & World Report (March 8, 2022) “How to Pay Less Tax on Retirement Account Withdrawals”

What Can I Do Instead of a Stretch IRA?

The idea of leaving a large inheritance to loved ones is a dream for some parents. However, without careful planning, heirs may end up with a large tax bill. When Congress passed the SECURE Act in December 2019, one of the changes was the end of the stretch IRA, as reported by Kiplinger in a recent article titled “Getting Around the Stretch IRA Block.”

Before the SECURE Act, people who inherited traditional IRAs needed to only take a minimum distribution annually, based on their own life expectancy. The money could grow tax-deferred for the rest of their lives. The tax impact was mild, because withdrawals could be spread out over many years, giving the new owner control over their taxable income. The rules were the same for an inherited Roth IRA. Distributions were based on the heirs’ life expectancy. Roth IRA heirs had the added benefit of not having to pay taxes on withdrawals, since Roth IRAs are funded with post-tax dollars.

After the SECURE Act, inherited traditional and Roth IRAs need to be emptied within ten years. Heirs can wait until the 10th year and empty the account all at once—and end up with a whopping tax bill—or take it out incrementally. However, it has to be emptied within ten years.

There are some exceptions: spouses, disabled or chronically ill individuals, or those who are not more than ten years younger than the original owner can stretch out the distribution of the IRA funds. If an underage minor inherits a traditional IRA, they can stretch it until they reach legal age. At that point, they have to withdraw all the funds in ten years—from age 18 to 28. This may not be the best time for a young person to have access to a large inheritance.

These changes have left many IRA owners looking for alternative ways to leave inheritances and find a work-around for their IRAs to protect their heirs from losing their inheritance to taxes or getting their inheritance at a young age.

For many, the solution is converting their traditional IRA to a Roth, where the IRA owner pays the taxes for their heirs. The strategy is generous and may be more tax efficient if the conversion is done during a time in retirement when the IRA owner’s income is lower, and they may be in a lower tax bracket. The average person receiving an IRA inheritance is around 50, typically peak earning years and the worst time to inherit a taxable asset.

Another way to avoid the stretch IRA is life insurance. Distributions from the IRA can be used to pay premiums on a life insurance policy, with beneficiaries receiving death benefits. The proceeds from the policy are tax-free, although the proceeds are considered part of the policy owner’s estate. With the current federal exemption at $12.06 million for individuals, the state estate tax is the only thing most people will need to worry about.

A Charitable Remainder Trust can also be used to mimic a stretch IRA. A CRT is an irrevocable split-interest trust, providing income to the grantor and designated beneficiaries for up to twenty years or the lifetime of the beneficiaries. Any remaining assets are donated to charity, which must receive at least 10% of the trust’s initial value. If the CRT is named as the IRA beneficiary, the IRA funds are distributed to the CRT upon the owner’s death and the estate gets a charitable estate tax deduction (and not an income tax deduction) for the portion expected to go to the charity. Assets grow within the charitable trust, which pays out a set percentage to beneficiaries each year. The distributions are taxable income for the beneficiaries. There are two types of CRTs: Charitable Remainder Unitrust and a Charitable Remainder Annuity Trust. An estate planning attorney will know which one is best suited for your family.

Reference: Kiplinger (March 3, 2022) “Getting Around the Stretch IRA Block”