I have two brokerage accounts, one is a regular account and the other is a Roth IRA. I need to withdraw some money on a regular basis from one or the other or both. Being in my 9th decade, I am concerned about the impact on my heirs about any tax issues when the will is probated.
As far as I know, it won't make any difference to my heirs if there is money left in the ROTH. I say that because it is my understanding that there is no mandatory annual distribution required for the Roth for my heirs. Is that correct?
All assets are part of the taxable estate, but the Roth is not included in probate proceedings. Your Roth custodian (Broker/bank) should have your beneficiary designation(s) on file for each IRA or Roth IRA you have. This will have the accounts bypass any named beneficiaries of you will.
Once the Roth is inherited, RMD's begin with rules similar to a pre-tax IRA. This offers the beneficiaries continued tax-free growth within the account. Given the choice, I'd rather have a Roth than a regular investment account.
TL:DR - yes, Roth is a bit better for beneficiaries.
Thank you for response. Roth is better for beneficiaries has been what my gut tells me so I have set up withdrawals from my regular account first. If that gets to zero, I'll switch to the Roth.
And the regular account will get a step up in basis upon death. And losses in the regular account will be lost upon death. So, I would sell from the regular account stocks with losses and enough stocks with gains to minimize the taxable gains.
I am not sure that a beneficiary is better off with a Roth with RMDs or a regular account with stepped up basis. Probably depends on how much a step up would be.
And even if were, that maximizes heirs' fortunes at expense of owner's current position -- and sounds as though he'd has likely use for the current income so from his perspective would seem counter-productive to not use the present tax advantage of the Roth.
A Roth with RMDs will always be better than a taxable account. The step-up in the taxable account doesn't do anything to avoid tax on future earnings (dividend and interest), just capital gains. Nothing in the Roth IRA generates taxable income.
If we assume that the beneficiary doesn't need any of the inherited assets for current living expenses, the Roth RMDs can be transferred to a taxable account, where their future capital gains will be based on the RMD FMV and dividends/interest will be earned on a smaller principal amount than if everything had been inherited in that taxable account.
No, it wouldn't. Let's assume the extreme situation of a regular account with cost basis of $1 and FMV of $1,000,001 at DoD and a Roth IRA worth the same amount. Both accounts contain identical investments. When the heirs sell shares in the regular account, they still have to pay 0-20% capital gain on the reduced gain due to step-up. (All sales of inherited assets are automatically long term.) The heirs still have to pay tax on any income the investments throw off (dividends/interest) before sale.
Sales in the Roth IRA generate no additional taxes, nor does the income stream. If the heirs take distributions from the Roth IRA "in-kind", the distributions assume a cost basis equal to the FMV at distribution so they effectively receive a step-up equal to the equivalent step-up plus unrealized gain in the regular account. As long as the "in-kind" shares are held another year outside the Roth IRA, they receive LTCG treatment. Of course, if there was any likelihood of selling the shares before one year, the tax could be avoided by selling the shares within the Roth IRA and distributing the cash equivalent.
No matter how you look at it, if you fully distribute the Roth IRA, reduce both accounts to cash, and pay any associated taxes, and fully distribute the Roth IRA, you have more cash in pocket from the Roth IRA.
The original question had to do with the impact on the heirs of actions taken now. The OP is in his 9th decade of life. The heirs will be better served by receiving the Roth IRA than by an equivalent amount in a regular account. I challenge you to provide a situation (with calculations) that reaches a different conclusion.
As I said in my own answer, I agree that Roth money is better than regular account.
What your foe 'might' be looking to describe is when the embedded gain is taxed on withdrawal by the owner. There's a tax paid which might otherwise be avoided by withdrawing from Roth instead, and let the beneficiaries receive the shock with stepped up basis.
But, as OP noted, the gains are minimal due to frequent re-allocation.
Even with the scenario I described, I rejected it as inferior given the possibility of the Roth having a stretch payout option. The cap gains avoided have the potential to be many times the gains Op would pay on the regular account. (Which means I agree with you 100%, and just guessing what the alternative view was.)
The answer to your original question is "It Depends". It depends on a variety of factors that you didn't tell us.
My simple conclusion is that your Heirs/Beneficiaries are probably better off if you take the money from the Roth.
Now, to the TL;DR part of the response that will explain my assumptions and analysis. Feel free to modify the assumptions to correspond to the reality of your particular situation.
It appears you have a periodic spending need that will require cash from either the Roth or the Brokerage account. For illustrative purposes I will assume you have periodic spending needs of $1000 and also assume the transactions costs in the Roth and Brokerage account are both zero.
You describe yourself as a person in the "9th decade" with a portfolio under "seven figures" that is "re-balanced at least annually". This implies a portfolio that probably has unrealized gains (possibly substantial) and could incur tax costs when a portion of it is sold. Your assumption that the cost basis step-up after death will be minimal because of the periodic re-balancing is likely wrong. At minimum, you should verify the accuracy of your assumption (Does your Brokerage statement really show total unrealized capital gains of near zero?). I have no way to know the effective tax burden when liquidating part of your Brokerage account so I am going to use 9% of the sales proceeds as the applicable total Federal/State/Local tax burden in my illustration.
- Option 1. Take $1000 from the Roth and spend it. The value of the Brokerage account remains unchanged.
- Option 2. Take $1100 from the Brokerage account, pay $100 in taxes, and spend $1000. The value of the Roth remains unchanged.
From your Heirs/Beneficiaries point of view, Option 2 leaves them with a $100 lower total (Roth + Broker) inheritance. In essence, you have paid $100 in taxes that they never would need to pay and it came out of their inheritance.
A more Complete and Complicated way to describe Option 2:
- Option 2. Sell enough from the Brokerage account to raise $1000 plus (or minus) the amount of taxes that will be incurred (or saved) as a result of the sale. There is a tax cost if there are net gains on the sales (you sold securities for more than you paid for them) and a tax savings if there are net losses on the sales (you sold securities for less than you paid for them) and you can take advantage of any tax loss.
What I would do: a) Sell securities in the Broker account that will generate Capital losses to meet a portion of your spending needs. Use the tax savings from the Capital losses to meet the rest of your spending needs. b) If a) doesn't generate enough cash, take the rest from the Roth.
I can think of scenarios. But the real issue is that there are a number of factors to consider, including the amounts in each type of account, the gain in the regular account, the needs of the owner, the likely uses/time frames of the beneficiaries, etc.
But your comments regarding potential benefits of Roths vs. regular accounts for the beneficiaries are well taken. As long as there isn't a tax penalty to be paid by the owner in order to preserve the Roth for the beneficiaries come hell or high water (since someone said it is ALWAYS better), which might result in less money given to the beneficiaries. Depending on taxes, etc., your assumption that the owners Roth and the owners regular account when given to the beneficiaries will be of the same amounts is not necessarily a given.
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