Give Early and Often

John Yeigh

KEY PROVISIONS IN 2017’s Tax Cuts and Jobs Act (TCJA) will expire in 2026 unless Congress steps in. That means folks have a two-year window to prepare.

What’s at stake? Income-tax rates will increase for many taxpayers. This creates an incentive to boost income over the next few years by, say, undertaking Roth conversions to shrink traditional retirement accounts and thereby lowering future required minimum distributions.

The sunsetting of key TCJA provisions would also cut the threshold for federal estate taxes in half, from an estimated $14 million per individual in 2025 to $7.1 million in 2026. The limit for married couples is double these amounts, though—to capture a deceased spouse’s estate-tax exclusion—the surviving spouse must typically file an estate tax return within nine months of the first spouse’s death.

Got wealth that’s above the projected 2026 threshold of $7.1 million for individuals and $14.2 million for married couples? You should almost certainly consult an estate attorney. Two common strategies are to use trusts or lifetime gifting to capture today’s high exemptions before 2026. The IRS has confirmed that there will be no “claw-back” if you take advantage of today’s high threshold.

The lower 2026 estate exemptions of $7.1 million or $14.2 million—assuming today’s higher limits are allowed to sunset—would continue to cover 99.8% of us. Still, retirees with a few million dollars of financial assets might want to review their estate plan, especially if they’re married or if they have significant assets in traditional retirement accounts, where all withdrawals are taxed as ordinary income.

Why? Married couples can face tax and income penalties after the first spouse dies—what’s commonly referred to as the “widow’s penalty.” The surviving spouse is potentially subject to the quadruple whammy of a reduced standard deduction, filing as a single taxpayer rather than married filing jointly, less Social Security income and possibly higher Medicare premium surcharges, otherwise known as IRMAA. These penalties could be further exacerbated if higher income-tax rates return in 2026.

Until now, my wife and I have followed the conventional estate-planning playbook, which is to name your spouse as the primary beneficiary, and then include children and possibly grandchildren as contingent or secondary beneficiaries. Some folks set up trusts so the surviving spouse receives income from the deceased spouse’s estate, with the estate then passing to later generations upon the second spouse’s death. For minor children or grandchildren, a trust often includes restrictions, so the inheritance is distributed slowly rather than all at once.

Given the various widow’s penalties, married couples with significant assets might consider an alternative beneficiary strategy, splitting the first spouse’s estate between the surviving spouse and the children. This may be especially worthwhile for those with “more than enough” wealth who have assets held in traditional retirement accounts. A hefty concentration in such accounts is an issue for us. Nearly three-quarters of our family’s financial assets are in traditional IRAs.

Adding children as partial IRA beneficiaries after the first spouse’s death offers at least three potential benefits: These assets get to their final destination sooner, the income-tax hit is spread across multiple beneficiaries and two “death periods,” and it helps reduce the surviving spouse’s taxable income. There’s also the chance for some tax-rate arbitrage if the children’s tax backets are lower than the surviving spouse’s marginal tax rate.

How do those two “death periods” help? Nonspouse beneficiaries now typically have to empty inherited retirement accounts within 10 years. By bequeathing a portion of traditional retirement accounts to children upon the first spouse’s death, rather than waiting to pass along the entire balance upon the second spouse’s death, the children will have two separate 10-year withdrawal periods to empty their inherited IRAs. This potentially reduces the income-tax hit by spreading withdrawals over a longer period.

True, this won’t help much if the spouses die soon after each other. But surviving spouses often live a decade or more after the first spouse passes. Keep in mind that, unlike with traditional retirement accounts, you might want to wait until the second spouse’s death to pass Roth accounts to the next generation, so the tax-free growth continues for longer.

The good news: All this is easy enough to do by simply changing retirement account beneficiary designations. My wife and I each took one of our IRAs, removed the other spouse as primary beneficiary and added our adult children instead.

We’re comfortable we won’t need this money to pay for our own retirement. What if we later change our minds—or tax laws change yet again? We can adjust our beneficiary designations at no cost, and without making potentially costly revisions to our estate-planning documents.

John Yeigh is an author, coach and youth sports advocate. His book “Win the Youth Sports Game” was published in 2021. John retired in 2017 from the oil industry, where he negotiated financial details for multi-billion-dollar international projects. Check out his earlier articles.

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