On 1/1/2020 there is a new law in town. The stretch method of wealth transfer will be kaput. The government has devised a new schedule that will assure them a lions share of your wealth upon your death. They will do it by nailing your children to the cross.
There are typically 4 asset classes that transfer IRA, Roth, Brokerage, Real Estate. in 2019 you could dissolve the assets in the IRA and the Roth as an heir over a very long time, even into your next generation i.e. the grand kids. You could leave the kids an IRA say IRA 1, but you could also name grand kids as beneficiaries in a separate IRA called IRA 2 which could grow unmolested for decades. Kids get money, pay ordinary income tax, but had control over how much income is removed so they had some control over taxes. No more. Starting next year Roth and TIRA needs to be emptied within 10 years of inheritance. If you have a combined 2M IRA and it grows at 5% your kid has to pull out $260K/yr as ordinary income. Depending on his income this could easily put him in the top tax bracket for 10 years, accelerating his tax bill and allowing the government a larger slice of your money than they otherwise have enjoyed.
This maneuver isolates the politicians. By the time you’re dead and your kids take over the money, the law is seasoned and “no one” is to blame. As a voting block the kids don’t even know they’ve been fleeced, and the grand kids don’t have the first clue. What’s a mother to do?
I’ve been playing with using the power of compounding, mixed with the power of lower tax rates to come up with an inter-generational solution using the gift tax. Each parent can gift 15K/yr per kid tax free, so if you have 2 parents and 3 kids you can gift up to 90K/yr. If you have 3 kids and 3 grand kids that becomes 180K/yr. What you want to do is set up a schedule of disbursement that eats into the principal of the IRA over the projected course of your life span. So if you start with 2M at 5% interest and have 20 years to live you need to pull out 160K/yr to empty the account in 20 years. 100K /yr keeps the account steady state at 2M. This gives you good control over disbursement. If you want to keep some money in those accounts till you die simply take out an amount somewhere in the middle. Lets say you pull out 130K/yr at the end of 20 years you would have $1M left in the accounts and would have transferred $4.3M in net value to your kids if they just put that money away and let it dollar cost average and compound for 20 years. This uses the tax law and compounding as a means of transferring a ton of wealth. In addition There will still be 1M in the accounts which will be disbursed over 10 years @ 130K/yr. By varying the disbursement vs the residual you can figure what disbursement is optimal for a given progressive tax code.
Your eyes may pop out at this and ask how can this be true? The answer is your money compounds no matter who owns it. If you start with 2M at 5% and never remove a dime after 20 years you will have 5.3M, the same 5.3 M you wound up with except you transferred 4.3M of that at a low tax rate and then had the additional 1M still in your account at the time of death. More money stays in your family less money goes to Uncle Sam. The particulars matter however. You can’t do this rule of thumb. You have to mathematically optimize and minimize taxes across 2 or more generations. Certainly a gamble but a gamble with a highly likely outcome since no one else is going to do the work involved in the optimization. The governments rules are designed to slaughter most of the people and it’s hard to write a law that covers 100% if there is some wiggle room and there is wiggle room.
A second strategy would be to take money in excess of RMD from the accounts and stick that in a brokerage. You would have to pay ordinary income taxes but if you optimized into a Roth you can pull Roth money into a brokerage tax free. Upon death the brokerage receives a step up in basis to the heir, and a brokerage has no expiration and a different taxation regimen. In addition, as the heir you may be able to tax loss harvest the brokerage over a long time, turning at least part of that account into a Roth like asset or a partial Roth like asset. You also have control over how much you take out depending on other income sources further optimizing your tax bill.
It’s complicated but it’s a puzzle that can be solved, and is worth being solved. I don’t have the details worked out yet, just the general framework, but my preliminary massage of the data shows this should work quite nicely.