Inherited IRA Exceptions and Other Tax Strategies To Help Clients

An Allianz tax expert outlined several strategies to help financial advisors minimize taxes for their retirement-age clients.

By Dorothy Hinchcliff

Consider a widowed client who has an IRA with a $4 million balance as well as a brokerage account. How can you help her minimize taxes for her heirs?

Steven Sweeney, CFP, vice president of advanced markets for Allianz, answered that question and others on how to minimize taxes for clients during a presentation on Sept. 28 at the Financial Planning Association’s national conference in Phoenix, Ariz.

Since Secure Act 1.0, signed into law by President Donald Trump on Dec. 20, 2019, most beneficiaries of inherited IRAs must withdraw the entire balance within 10 years. A major exception is surviving spouses. However, there are a few other lesser-known exceptions to that rule.  And perhaps the one that may provide the most opportunity for advisors to help clients manage taxes is the exception for an inheritor who is not more than 10 years younger than the person who left them the IRA, Sweeney said.

In that case, Sweeney pointed out, the inheritor does not have to withdraw the entire IRA balance within 10 years and instead can take distributions based on their own life expectancy.

Suppose that widowed client has two beneficiaries — one is a child and one is a brother or sister who is two years younger than she is, Sweeney said. The child wouldn’t be eligible for the stretch option, but the brother or sister would.

“Most people with two beneficiaries, say ‘I’m going to name each of them 50% beneficiaries of all my accounts,’ which is fine,” Sweeney said. “But you may be leaving something on the table as it relates to tax efficiency because that child who inherits 50% of an IRA is going to be subject to the 10-year requirement. But the sibling is going to be able to stretch that based on their life expectancy with a lot more tax efficiency.”

A good strategy might be to leave a larger portion of the brokerage account to the child and a larger portion of the IRA to the sibling, Sweeney said.

Most of the other exceptions to the 10-year rule generally won’t be as useful for tax-efficiency strategies, Sweeney said. For example, there is an exception for a disabled or chronically ill person who inherits an IRA, but the rules are very stringent on who qualifies, he added.

Sweeney also addressed other areas where advisors could look to help clients minimize taxes. Having a tax-diversified portfolio is perhaps the biggest opportunity, but there are others, he noted.

One issue clients may face as their income increases is the net investment income tax, Sweeney said. The 3.8% tax is on the lesser of net investment income or modified adjusted gross income that exceeds $250,000 for married filing jointly or a qualifying surviving spouse, $125,000 for married filing separately, or $200,000 for a single or head of household.

“This can eat away at the probability of success in retirement because it’s not about what you make, but what you get to keep,” he added.

Staying in the 22% bracket

Federal income tax rates are also something to consider for high-earning couples as they begin retirement. Sweeney noted that for 2023, a couple that is married filing jointly is in the 22% bracket as long as their income doesn’t exceed $190,750.

“There is an enormous opportunity moving forward to manage these tax brackets,” he said. “I like to think about the 22% tax bracket as sort of the sweet spot for some of our wealthier clients. It jumps up from there quite significantly.”

Roth conversions and surviving spouses

In the first few years of their retirement, he said, a couple may have an opportunity to stay in that 22% bracket by doing a partial Roth conversion. “That helps mitigate the concerns relating to capital distributions from traditional IRAs, as it relates, for example, to Medicare … and the extent to which Social Security is taxed,” he said.

Sweeney said most people, when they think about Roth conversions, believe they either make too much money to do one or they don’t want to pay the taxes associated with the conversion.

But think about a married couple where one spouse then passes away. The surviving spouse, on average, will live another 10 years, he said.

“There’s a high degree of probability that that single taxpayer is in a much higher tax bracket, which can have an enormous impact,” he said.

Converting a portion of the IRA could mean that a surviving spouse will pay less in taxes later when he or she is in a higher tax bracket and needs to take distributions, Sweeney said.

Roths and IRMAA

He added advisors should be aware of the negative consequences of a Roth conversion, particularly how it might increase Medicare Part B and D premiums. The standard part B monthly premium is currently $164.90, but there are income related monthly adjustment amounts (IRMAA) for individuals with modified adjusted gross income (MAGI) over $97,000 and joint filers earning more than $194,000.

“We know our [IRMA] brackets are based on income from two years prior. So we have a 63-year-old who’s engaging in this conversation,” he said. “When they turn 65 and they go on Medicare, that higher income [from the conversion] could also plug them into higher earnings.”

Charitable strategies

Sweeney also discussed charitable contribution strategies. For clients interested in making charitable contributions who have built up large IRA balances but would rather not pay taxes on that income, the opportunity for qualified charitable distributions (QCDs) is as good as it’s ever been, he said.

I think the biggest takeaway here, more than anything else, is that [the U.S. government] didn’t change the age at which we’re eligible to make these QCDs. So if we’re sitting with a client who’s 70 years old and they’ve got a big balance in their IRA … you can start them in the year in which they turn 70 … Those distributions are tax-free to them.”


Sweeney also mentioned strategies for health savings accounts (HSAs). Although the contribution limits aren’t great, they can present an enormous opportunity to address healthcare costs in retirement, Sweeney said.

While people are working, they can fully fund HSAs and get a triple tax benefit if an HSA is available to them through their employer. “It is true that once you’re on Medicare, you are no longer eligible to contribute to your HSA … however, if there is a residual balance, you can carry that forward and pay for any ancillary expenses.”

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