Your Money, Your Wealth Podcast Episode 504: Rules for Inheritances and Making Roth Contributions for Others

Release Date: November 19, 2024

Hosts:

• Joe Anderson, CFP®
• Big Al Clopine, CPA

In Episode 504 of Your Money, Your Wealth (“YMYW”), hosts Joe Anderson and Big Al Clopine delve into intricate financial scenarios involving inheritances, Roth IRA contributions, and strategic tax planning. This episode features insightful discussions on handling inherited trusts, joint ownership complications, spousal Roth contributions, and sophisticated Roth conversion strategies. Below is a comprehensive summary capturing all key points, notable quotes, and expert conclusions.

1. Inherited Trusts and Roth Conversions: Ted and Georgette's Dilemma

Listener Profile:
Ted and Georgette from Madison, Wisconsin inherit $1.6 million through a trust and seek advice on converting these funds to a Roth IRA without triggering distributions.

Issue Raised:

• Can Ted and Georgette convert the inherited pre-tax money to a Roth IRA without distributing it?
• Should the trust own their home to utilize home equity for tax payments?

Discussion Highlights:

• Nature of the Trust:
  Big Al clarifies that inherited trusts are often irrevocable, meaning the beneficiaries have limited control over the corpus. “[05:17] Big Al Clopine: ...most cases, you want to keep the assets,” he explains.

• Tax Implications:
  Distributions from the trust can be taxable based on the type of income (interest or dividends). Capital gains are typically taxed within the trust unless distributed.

• Roth Conversion Strategy:
  Joe summarizes the situation, pointing out that the trust holds $1.6 million with a $1.2 million basis, resulting in $400,000 of potential capital gains. “[08:00] Big Al Clopine: ...there's no reason to buy a home through the trust. In fact, that would be a terrible idea…”

• Payment of Taxes:
  Big Al recommends using trust assets to pay conversion taxes by selling assets with minimal gains. “[09:31] Big Al Clopine: ...use trust assets to pay the tax for the conversion.”

Notable Quote:

“[09:31] Big Al Clopine: There's no question. So should he do conversions? Yes. And can you use the trust assets to pay the tax? Yes, you can.”
— Big Al Clopine

2. Joint Ownership and Gift Tax Concerns: Melissa's Challenge

Listener Profile:
Melissa from Rockport, Texas adds her name as a joint owner on her parents’ bank accounts following a medical crisis, becoming the executor and a 50% beneficiary alongside her nephews.

Issue Raised:

• Potential gift tax implications due to joint ownership.
• Concerns about step-up in basis and equitable distribution among nephews.

Discussion Highlights:

• Gift Tax Implications:
  Joint ownership can trigger gift taxes, as transferring assets may exceed annual exclusions. “[14:11] Joe Anderson: That would. Because what's the annual gift?”
  Big Al suggests consulting an estate planning attorney to address possible gift tax returns.

• Step-Up in Basis:
  By becoming a joint owner, Melissa forfeits the step-up in basis, potentially increasing capital gains taxes for beneficiaries.

• Recommended Solutions:

  • Utilize Transfer on Death (TOD) designations to allow multiple beneficiaries without incurring gift taxes.
  • Consider placing assets within a trust to maintain beneficiary designations and avoid unintended tax consequences.

Notable Quote:

“[15:31] Joe Anderson: ...you have to file a gift tax return.”
— Joe Anderson

3. Spousal Roth IRA Contributions: Theodore's Query

Listener Profile:
Theodore from Seattle, Washington, aged 61 with spouse Louise (60), both approaching retirement. They seek guidance on contributing to a Roth IRA for his wife.

Issue Raised:

• Can Theodore contribute to Louise’s Roth IRA despite not having current earned income?
• Strategies for maximizing Roth contributions and handling taxes.

Discussion Highlights:

• Spousal Roth IRA Eligibility:
  Joe clarifies that spousal contributions are permissible if one spouse has earned income. “[19:12] Joe Anderson: ...it's called a spousal Roth IRA or spousal IRA contribution. So good to go.”

• Contribution Limits and Planning:
  Both spouses can maximize their Roth contributions independently, considering income limits and tax brackets.

• Roth Conversion Advice:
  Big Al advises Theodore to use taxable or brokerage accounts to pay conversion taxes, ensuring that retirement funds remain intact. “[22:22] Big Al Clopine: ...use your brokerage account to pay the tax.”

Notable Quote:

“[20:40] Joe Anderson: ...if you're married to her, then you can put money into a Roth. It's called a spousal Roth IRA...”
— Joe Anderson

4. Advanced Roth Conversion Strategies: John’s Comprehensive Plan

Listener Profile:
John from Colorado, retired at 63 with a substantial traditional IRA portfolio seeking sophisticated strategies for Roth conversions and tax management.

Issue Raised:

• Whether to convert $7 million in traditional IRAs to Roth IRAs while managing tax liabilities.
• Concerns about inheritance tax implications for children and overall tax efficiency.

Discussion Highlights:

• Roth Conversion Feasibility:
  Big Al acknowledges the complexity but supports conversions up to the top of the 24% tax bracket, suggesting careful mapping. “[32:44] Big Al Clopine: ...you have to be careful that you pull enough to pay the tax.”

• Tax Payment Strategies:
  Considering John's lack of post-tax income or sizable savings, Big Al proposes borrowing against real estate (HELOC) to pay taxes, minimizing direct withdrawals from retirement accounts. “[35:05] Big Al Clopine: ...borrow on your home...”

• Long-Term Planning:
  With John's retirement timeline, leveraging loans to handle immediate tax burdens allows for continued growth of IRA assets, optimizing future financial stability.

Notable Quotes:

“[35:05] Big Al Clopine: It is a heck of an idea... rates are high and it's not usually a very good idea. But in this case... borrow on your home...”

“[37:54] Andi Last: ...your financial assessments...”

Additional Insights and Resources

• Cybersecurity Awareness:
  Andi Last highlights the importance of protecting financial assets from online scams and identity theft, promoting a cybersecurity webinar and an identity theft guide.

• Promotion of Free Resources:
  Listeners are encouraged to download the "Top 10 Tax Tips Guide" and watch related webinars to enhance their financial literacy.

Notable Quote:

“[28:40] Andi Last: ...learn about common scams and tactics and the best practices to adopt that will improve your digital safety...”
— Andi Last

Conclusion and Upcoming Content

In wrapping up the episode, Andi Last informs listeners about the scheduling for next week's episode, promising answers to additional listener questions. The hosts also invite feedback and reviews across various podcast platforms and encourage scheduling comprehensive financial assessments with Pure Financial Advisors before year-end to prepare for upcoming tax changes.

Final Quote:

“[37:54] Andi Last: ...meet with our team either in person or online...”
— Andi Last

Key Takeaways:

• Inherited Trusts Require Strategic Planning: Understanding the type of trust and its tax implications is crucial for effective Roth conversions.
• Joint Ownership Can Trigger Unintended Tax Consequences: Utilizing tools like TOD designations and trusts can help manage beneficiary distributions without incurring gift taxes.
• Spousal Roth Contributions Offer Flexibility: Even without direct earned income, spouses can benefit from Roth IRA contributions through spousal arrangements.
• Sophisticated Roth Conversion Strategies Involve Balancing Loans and Taxes: High-net-worth individuals might explore borrowing options to manage tax liabilities efficiently.

Listeners gain valuable insights into navigating complex financial scenarios, emphasizing the importance of tailored strategies and professional guidance to optimize wealth management and retirement planning.