Reader Question: After my dad passed away last year, my mother came to live with my wife and me. She has an estate worth about $1,500,000 including $400,000 in cash; $800,000 in annuities (both non-qualified and qualified); $100,000 in a 5-year CD; $160,000 in one stock of a publicly traded large bank; and $90,000 in a short-term CD for my 3 kids. I am the only child and she has my name on everything she owns… even her auto. What can we do to avoid taxes to me at her passing? She is in good health and is 81 years old. Thanks for your help. D.A.
Answer: Good news on three fronts!
- Probate avoided. Since your mother has gone to the trouble of putting your name on all of her assets, at her death her estate will not be subject to probate. Probate is a court-administered process that ensures her assets are properly transferred according to her wishes either through her will or according to state law, if she dies without a will. While probate costs for Alabamians is relatively low, the fees can be hundreds, if not thousands of dollars. Probating a will also takes six months or longer. It is also a public process…meaning the information about one’s estate is part of the public record and accessible to anyone who chooses to go to the trouble to look.
- No estate taxes. Under current law, a deceased person whose estate is less than $5,430,000 (2015) is not subject to estate taxes.
- Step-up income tax basis. At death most of the assets in your mom’s estate will receive a ‘step-up’ in tax basis. For example, let’s say your mom paid $60,000 for her bank stock that is now worth $160,000. If she were to sell it during her life, $100,000 of gain would be subject to long-term capital gains taxes. However, if she died owning the stock, you’d receive a step-up in tax basis based on the fair market value at the time of death (the full $160,000). You could then sell the stock the next day and you’d owe no taxes.
Both the qualified and non-qualified annuities (along with any qualified retirement plan such as an IRA) do not qualify for step-up tax basis rules. One idea your mom might consider is ‘spending down’ her annuities particularly to the degree she can take money out in lower tax brackets (10%-15% tax brackets). If you inherit these annuities, you’ll also inherit the built in tax problems.
Reader Question: Does it make sense to do a Roth IRA conversion at age 65?
Answer: I assume you’re referring to how long you need to hold a Roth after conversion in order for it to be worthwhile considering the taxes you paid to do the conversion. The alternative being that you simply continue to hold a traditional IRA where any distributions would be taxable. There are a couple of ways to think about this. First, we’d avoid doing a conversion in the highest tax brackets (39.6% and 35%). If you can manage to convert in lower tax brackets, say 15%, we’d strongly consider this. At age 65, statistically you’ll live twenty years or longer so that’s probably enough time for it to favor a conversion, particularly if you’re converting in lower tax brackets. If your children would have the good sense to take only minimum required distributions from the Roth, this is a significant fact in favor of a Roth conversion.