For the vast majority of clients, individual retirement accounts with a lot of assets represent a great goal. But bigger is not always better.
To the small number of wealthy families who are subject to an estate tax, two experts define a qualified retirement plan or an IRA that is around half or more of an estate as an “elephant IRA.” And they’re warning financial advisors and tax professionals that those families may be setting themselves up for a tax or penalty hit — even if they have a Roth IRA.
“That brings in a whole host of other issues,” said Griffin Bridgers, a member with the Hutchins & Associates law firm, where he focuses on private wealth and family businesses. Restrictions on so-called prohibited transactions in IRAs, guidelines for withdrawals and and other factors add up to a system of “byzantine rules” that may appear distant today, he noted. But they could pose problems in the future for wealthy clients and their estate trustees.
“They’re sure to mess something up along the way,” Bridgers said. “If you do have estate tax liability, it’s pretty messy.”
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The problem with concentrated wealth
Bridgers and Leonard “Paul” Hood, a veteran estate and tax planning lawyer who is the founder of Paul Hood Services, dove into the key strategic problems with elephant IRAs in a webinar held earlier this year by Leimberg Information Services, a training and educational resource for for financial professionals with high net worth customers. The basic prohibitions on borrowing from either type of IRA, as well as selling property to the entity, using them as a security for a loan or using the money to buy property for personal use explain why they are often not the best place for such a large concentration of holdings out of a wealthy family’s overall assets.
“Why convert to Roth only?,” Hood said, citing those limits from the Employee Retirement Income Security Act. “Why not get out of ERISA altogether? … You’ve paid your toll. Why not get out of the gate? Go through the turnstile. You’ve paid your ticket. Otherwise, you’re trapped.”
Roth IRAs constitute more than $1.4 trillion in retirement assets based on the appeal of paying taxes up front to avoid them down the line and the fact that they do not have required minimum distributions during the account owner’s lifetime. To be sure, the number of families who must worry about the estate tax will keep dwindling under the expanded federal exemption of the One Big Beautiful Bill Act signed into law by President Donald Trump this past July. But the clients who may be subject to it one day must look beyond the tax deferral of a traditional IRA or even the after-tax characteristics of Roth accounts, Bridgers said.
“We can add quick value by avoiding or deferring income tax today, but there’s rarely thought to the long-term consequences,” he said. “There’s wisdom in asking, ‘Does an IRA structure continue to make sense for us?'”
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Other paths to consider
In certain cases, simply making qualified charitable distributions could lead to lower tax liability. In others, sophisticated trust planning could bring more flexibility. But Bridgers and Hood argue that an elephantine-sized IRA won’t likely end up giving wealthy estates the full advantage of their massive holdings in the end.
Paul recalled a client he had decades ago who had $20 million in his estate, yet developed a habit of using then-nascent available trading technology to execute transactions in say, Australian futures, at 3 a.m.
“He got obsessed as a day trader trading 24 hours a day in his IRA, and he calls me, and he says, ‘I just got my IRA up to $9 million.’ I said, ‘What in the hell are you doing?'” Paul said. “‘None of this is going to end up in your family. I’m going to tell you right now, my recommendation is, name a charity as the beneficiary and be done with it. They get 100% of the dollars, and you don’t have to pay any estate tax on it or income tax.'”
