Multi-Generational Tax Planning with Retirement Accounts

The Opportunity:

While retirement accounts offer appealing tax breaks up front, they often generate outsized tax burdens over the course of a career, retirement, and beyond. Consider a multi-generational time horizon in your distribution plan to create optimal tax savings for the greater family unit.

Background:

Owners of retirement accounts (IRA, SEP IRA, 401(k), 403(b), pension) have enjoyed the benefit of tax deductions on incoming contributions, and the tax-deferred growth, often over a period of several decades. The income tax liability embedded within account balances is deferred until distribution from the accounts, when income is then recognized and tax is assessed.

Essentially, one could say retirement accounts are owned in partnership with federal and state tax authorities, whereby the state and federal government share is determined by the tax rates of the individual account holder at the time of the distribution. To minimize the government share, account holders would prefer to “buy them out” at favorable rates; ideally distributing or converting (to Roth IRA) balances during lower-income tax years and avoiding distributions/conversions during higher-income tax years.

Any remaining retirement account balance at the account owner’s death still carries the embedded tax liability, which is often passed to heirs at a time when they are in peak earning years (and top tax rates). Remaining assets must be distributed from inherited IRAs of non-spouses over the next 10 years, often pushing the government share of those accounts higher than they could have otherwise been.

Current Moment:

A massive transition of intergenerational wealth is currently underway, rotating assets from baby boomers to their children and grandchildren. At the same time, we are facing a strong likelihood of higher tax rates in the future. Absent the passage of tax legislation in the interim, individual tax laws are set to revert to the pre-Trump era, on January 1, 2026. In the interim, there is an opportunity to take advantage of the favorable tax environment for the 2024 and 2025 tax years by voluntarily distributing assets from IRAs or converting to Roth.

For account holders facing a potential estate tax liability, the death tax would be assessed upon the entire value of remaining retirement accounts, including embedded income tax liabilities. For these individuals, fully distributing/converting retirement balances prevents a situation where embedded income taxes are also subject to estate tax. At higher asset levels, planning around retirement accounts is a matter of managing layers of liability (income tax and estate tax) at both the federal and state levels.

The Solution Set:

Tax liabilities embedded within retirement accounts cannot be avoided but can be managed and mitigated. Navigating the best course requires diligent planning and execution, especially through the scope of a multi-generational lens. To this point, consider not only the taxes to be eventually passed on to your children, but also the retirement accounts and taxes that may still be passed to you.

Working with longer timeframes generally provides greater flexibility and opportunity. In the short term, there is still time to take advantage of the favorable 2024 tax environment. While each individual situation is different, the potential benefits are well worth exploring with your JMG advisor.

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