Roth IRAs also have advantages over regular IRAs when it comes to estate planning . For inherited regular IRAs , the future distributions are classified as “ income in respect of a decedent ” and are both 1 ) includable as a taxable asset at face value in the estate of the decedent and 2 ) considered taxable income when distributed to the beneficiary . Thanks to the 2020 legislation known as the Secure Act , regular IRAs left to a nonspouse — in other words , the account holder ’ s children — must now be distributed within 10 years of inheritance .
So if parents die in their 80s and leave regular IRAs to children in their 50s , this 10-year RMD regime coincides with the kids ’ peak earning years ( and peak tax brackets ). In the worst-case scenario , the regular IRA triggers both an estate tax ( with a paltry basis adjustment under Section 691 of the Internal Revenue Code ) and the income tax ( under the high brackets ) on most of the distribution amounts . The combined tax cost of this “ double tax ” can be as high as 70 %.
At estate tax seminars presented to knowledgeable estate planners , I generally recommend leaving regular IRAs to charity in order to avoid this hassle , and then ( facetiously ) comment , “ You should only leave regular IRAs to your children as a prank .”
The 10-year distribution requirement also applies to inherited Roth IRAs , but if the decedent satisfied the five-year rule before they died then the withdrawals are tax-free . It makes a Roth IRA a better estate planning tool than the regular IRA , where taxes bunched into a 10-year post-death period can substantially erode the value .
Will Tax Rates Increase ?
All this raises another question : What in the heck is going to happen in the future with federal and state income tax rates ? The answer is , “ God only knows , and even God is hedging the bets .”
On the one hand , it is easy to look aghast at federal government spending deficits , the endless growth of state and local government , and conclude
In the worst-case scenario , the regular IRA triggers both an estate tax and the income tax ( under the high brackets ) on most of the distribution amounts .
that taxes must necessarily rise , and thus conclude that the Roth IRA is likely to produce a better end result over time .
But marginal income tax rates have a weird history . The maximum federal income tax rates at the end of World War II were as high as 90 % ( or more ). They were still at 70 % in the 1970s . These rates spawned a huge tax-avoidance industry , enabled by a compliant Congress that approved a plethora of tax shelters , and very few people paid the top rate . That rate dropped to 50 % in 1981 and then down to just 28 % ( briefly ) in 1986 under President Reagan . At the same time , the vast majority of tax shelters were eliminated , hurting formerly tax-favored industries like real estate and oil and gas .
The peak rate soon bumped back up to 31 % under President George H . W . Bush in 1990 , then to 39.6 % in the Clinton era , back down to 35 % in the George W . Bush era , back up to 39.6 % under Obama and down to 37 % under Trump . Joe Biden tried , unsuccessfully , to raise tax rates back up to 39.6 %. For more than 30 years , the top marginal rate has remained in a relatively narrow band between 35 % and 40 %.
Federal tax policy has been affected by the famous Laffer curve and similar theories suggesting that maximum income tax rates do not produce max-
imum revenues , and everyone pretty much accepts this observation . Even Sen . Bernie Sanders has said he would not raise rates to the 90 % levels of the Eisenhower years . You might conclude , taking all this history into account , that people will resist federal income tax rates jumping much higher than 39.6 %, and so there won ’ t likely be a quantum leap from the current rates . An interesting conclusion to reach , if you reach it .
Meanwhile , at the state level , competition among jurisdictions to slash rates has had a major impact , and some states , still flush with federal cash after the pandemic , now recognize that raising tax rates can lead to the flight of high-income individuals ( and their businesses ) and cause a net diminution in tax revenues . My home state , Massachusetts , raised the maximum tax rate on those making more than $ 1 million to 9 % ( and reclaimed its old nickname , “ Taxachusetts ,”) but almost every other state has either kept taxes the same or cut them — more than 20 states slashed taxes in the past three years .
Those in states with high income taxes can easily retire and move elsewhere , in the process slashing a New York state income tax of 12.4 % or a California tax of 13.3 % to zero . A call to the Mayflower moving company just before you turn 73 means that you could now fund the reg-
26 | FINANCIAL ADVISOR MAGAZINE | SEPTEMBER 2023 WWW . FA-MAG . COM