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Keep in mind that ending stepped up basis is part of the infrastructure bill now in Congress. No telling if they will pass it and what will be in it, but the Biden proposal is an exemption of $1MM on your death but then paying capital gains at a rate of about 40%.

If your plan falls below that $1MM exemption, you should be ok, but if more money is involved, watch out. This is one of the wealth taxes under consideration and being actively debated. They also want to lower the estate tax exemption to $3.5MM.
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Im 60, about to retire. We plan to live on our 401K and a pension. Our hope is our traditional IRA's will be surplus, passed on to our 2 adult kids. I was planning on converting them to ROTH, but now I'm thinking it may be best to cash them out over time, repurchase our stocks and funds, and our kids will inherit with a step up cost basis. Am I wise, or nuts?
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Not necessarily nuts, but: If your kids inherit your IRAs, whether traditional or Roths, they will have to withdraw the balance by the end of the 10th year after your death. The timing will be up to them.
It might be cheaper for you to do Roth conversions and pay the taxes, on a schedule that makes sense for you. Or it might be cheaper for them to inherit traditional IRAs and pay the taxes over 10 years.
To know which is better, you would have to compare notes with your kids about taxes and other financial factors.
Or, should your living expenses or medical expenses increase in the years to come, you might be best off keeping the money where it is.

Bill
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I was planning on converting them to ROTH, but now I'm thinking it may be best to cash them out over time, repurchase our stocks and funds, and our kids will inherit with a step up cost basis. Am I wise, or nuts?

In addition to Wradical's excellent reply that it depends a lot on your particular situation, also keep in mind that tax law can change before you die.

AJ
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In terms of taxes you pay, a ROTH conversion from a traditional IRA or just withdrawing from an IRA are the same. However the money in the ROTH will never be taxed, so there is no need to play games with step-ups. As you have been told, your heirs have ten years to drain both traditional IRA and ROTH, but the ROTH money will not cause taxes.

Comparing leaving the money in the traditional IRA vs doing ROTH conversions, it all comes down to tax brackets. What tax bracket will it be taxes at when you convert it? Compare that to what tax bracket your heirs will be taxed at when withdrawing it over the ten year period. Lots of guesswork and assumptions to make.
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Thanks all, for the valuable info. I was thinking that the inherited ROTH would be taxed, but apparently I am wrong. If I pay the tax now, the funds can grow tax free for me, and passed on was free to my heirs. That's a significant point to get wrong!
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Im 60, about to retire. We plan to live on our 401K and a pension. Our hope is our traditional IRA's will be surplus, passed on to our 2 adult kids. I was planning on converting them to ROTH, but now I'm thinking it may be best to cash them out over time, repurchase our stocks and funds, and our kids will inherit with a step up cost basis. Am I wise, or nuts?

The following two MarketWatch articles by Mark Hulbert might be of interest along with the paper by Edward F McQuarrie referenced in Hulbert's articles.

https://www.marketwatch.com/story/to-roth-or-not-to-roth-116...
https://www.marketwatch.com/story/to-roth-or-not-to-roth-par...
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3860359

I didn't get around to retiring until age 68 and started RMD withdrawals at age 70. My conclusion was that Roth conversions wouldn't appreciably change my RMD and I would never recover the cost of the conversions before I died. The McQuarrie paper basically supports my conclusion.

My approach to passing on wealth to my three children has been to move the RMD to a taxable investment account and buy stocks that they would inherit. The number of shares of each stock is a multiple of 3 so that each child gets an equal share of each stock. The stock values will be stepped up in value (hopefully) when I die and they won't need to sell the stocks within a 10 year period.
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Now THAT is a brilliant approach, MCC - thank you for posting that. A number of years behind you but needing to learn other approaches to avoid the obnoxious 10-year RMD rule. (Other than blowing it all on me & DW which may still happen ;-)
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Same here except that we started moving money from our sheltered accounts to our taxable accounts when I retired at 62. We are presently taking out just enough to put us up to the Medicare threshold ($176,000) without going over.

We will also invest our RMD's in taxable accounts when the time comes, which will probably put us in a higher tax bracket.

But whatever makes it to our daughters will not be subject to RMD rules because most of it will already be in taxable accounts by then.

Also trying to spend more on on us on the theory that we earned it, but habits are hard to break.
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Keep in mind that ending stepped up basis is part of the infrastructure bill now in Congress. No telling if they will pass it and what will be in it, but the Biden proposal is an exemption of $1MM on your death but then paying capital gains at a rate of about 40%.

If your plan falls below that $1MM exemption, you should be ok, but if more money is involved, watch out. This is one of the wealth taxes under consideration and being actively debated. They also want to lower the estate tax exemption to $3.5MM.
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No. of Recommendations: 11
I think there is another point to consider as well: What tax bracket are your kids in? Some parents have accumulated significant wealth with "modest" income while their children might have high paying jobs (and/or live in high tax states). In this case there could be a significant increase in the marginal tax rate paid on the money coming out of a traditional IRA/401(k).

For example, consider parents living in Washington State (no income tax) with income of 100K. Suppose further that their two kids live in San Francisco and NYC and each earn 500K+ a year. For the kids, a marginal dollar coming out of an inherited traditional IRA would be taxed at 45-50%. For the parents, a marginal dollar being converted to a Roth would be taxed at around 25%. So, in this type of situation, there is a pretty big opportunity for what I call "marginal tax rate arbitrage."

Just another wrinkle...
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What if the parents have a trust that is the beneficiary of their IRA and their children as trustees. Could the kids avoid taxes by simply leaving the IRA in the trust until their own income drops or they move to a lower tax state?
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What if the parents have a trust that is the beneficiary of their IRA and their children as trustees. Could the kids avoid taxes by simply leaving the IRA in the trust until their own income drops or they move to a lower tax state?

I only spent a short time in law school before being invited to participate in the Vietnam War fiasco and have no experience as a tax law specialist.

That being said, the SECURE Act appears to have taken away some of the advantages of designating a trust as a beneficiary. A trust is not an eligible designated beneficiary and thus requiring the trust to empty the IRA in 10 years. The trust as beneficial owner of the IRA is taxed at 39.6% of any income received from the IRA unless it passes the income to the trust's beneficiaries through a Schedule K-1.

Again, I'm not a legal expert. YMV.
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What if the parents have a trust that is the beneficiary of their IRA and their children as trustees. Could the kids avoid taxes by simply leaving the IRA in the trust until their own income drops or they move to a lower tax state?

Technically, yes. The kids avoid the tax.

Unfortunately, the trust would pay taxes instead. Trusts pay taxes at rates that are almost always higher (and often a LOT higher) than the kids would pay on the same income.

So leaving the IRA to a trust is not a good solution.

--Peter
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