THE SECURE ACT – A Soap Opera of Tax and Estate Planning

Written by Jeff Walker, Financial Planner:

There are many risks people face before and throughout retirement.  Most people understand stock market risk, healthcare risk, and inflation risk but the risk of losing wealth due to taxes is one that is often overlooked or misunderstood.  Unfortunately, understanding tax risk isn’t simple or intuitive and the reality is the government can change the way taxes affect our retirement in several ways.

  • Tax brackets and income thresholds can change.
  • Tax credits and deductions can be limited or reduced.
  • New taxes or new tax laws can be created.

The Secure Act is one example of a new tax law that has dramatically changed the way tax-deferred retirement accounts transfer to the next generation.  This law was passed in 2019 and had several major changes, such as pushing back the RMD (Required Minimum Distribution) age from 70.5 to 72 and it also eliminated the Stretch IRA.

Prior to this law, beneficiaries who inherited tax-deferred retirement accounts were required to take an annual RMD but were permitted to stretch that distribution over their entire life expectancy.  The advantage was by stretching the distribution out it reduced the taxable income and allowed those assets to continue to grow tax deferred.  Under the new law, for deaths in 2020 and beyond, beneficiaries are no longer required to take an annual RMD but must liquidate the entire inheritance in just 10 years.

There are 5 categories of beneficiaries that are not subject to the new rule and could still utilize the stretch IRA: surviving spouses, minor children, disabled individuals, chronically ill, and beneficiaries not more than ten years younger than the IRA owner.

Almost 3 years after the law was passed, the IRS just announced how they would enforce this law and they added even more complexity by creating a new term called the Required Beginning Date (RBD).

If the original IRA owner passed away on or after the Required Beginning Date (RBD) of their RMD, then the beneficiary would also be required to continue taking an annual RMD and the account must be emptied within the 10-year period.

If the original IRA owner passed away before their RBD date (in other words, not taking their RMD) then the beneficiary would not be required to take an annual RMD, but the account must still be distributed within the 10-year period. The IRS has also not commented on what will happen to those who did or didn’t take an RMD over the past 3 years.

If all that wasn’t enough, Congress is now contemplating SECURE 2.0, which will have further provisions if it passes.

Simple, right?

Given these changes, there are several things to consider.

  1. Consolidate & Review Beneficiaries: If you have multiple retirement accounts, it may be time to consolidate to make things easier to manage. You should also review each account to make sure that your money is going to whom you intend.  Spousal beneficiaries are more important than ever because they still fall under the old rules and are exempt from the new 10-year rule.
  2. Trusts as Beneficiaries: A common estate planning technique for clients with substantial retirement plan assets is to name a trust as the beneficiary. Trusts can provide the controls and protections such as ensuring that a beneficiary (such as a child) does not receive a substantial and immediate outright gift. The SECURE Act may upend a number of these goals where IRAs are directed to trusts. For example, if you have a trust and the trust deems that a child can only receive up to $10,000 per year of income, but the SECURE act requires that they take an annual distribution of $15,000 per year, the trust is now obsolete. IRS rules will trump any trust provisions that are not in compliance with the new beneficiary rules as described above. If you have a trust listed as a beneficiary, you will want to review the trust provisions and language to make sure it is in alignment with the Secure Act.
  3. Consider Roth Conversions: When you convert a traditional IRA to a Roth IRA, you pay tax on the amount converted. The Secure act did affect inherited Roth IRAs – even though there aren’t RMD’s… a designated beneficiary is required to liquidate the account by the end of the 10th year following the year of death of the IRA owner (this is known as the 10-year rule). Funds will grow tax-free and can be distributed tax-free and beneficiaries will inherit these funds tax-free as well.
  4. Charitable Remainder Trust:  When a CRT is created, you name two beneficiaries.  The first is the child that will receive the income from the trust for a period – up to their lifetime.  The second is designated charity; the trust is NOT funded until you die, when that happens it triggers the transfer of the IRA to the CRT.  Using a CRT means that your child will not recognize a large immediate taxable distribution.  Nor will your child be forced to endure the accelerated 10yr distribution imposed under the SECURE Act.  The assets placed in the CRT are allowed to grow tax-deferred because it is a charitable instrument and by stretching out payments over the child’s lifetime, the CRT strategy closely mimics the previous Stretch IRA strategy.  The main difference compared to the Stretch IRA, what remains in the CRT when your child passes will go to charity.
  5. Life Insurance: Life insurance is income-tax-free and can be estate-tax-free, so individuals may want to consider using it as a planning vehicle. Assuming the IRA/qualified plan owner is taking required minimum distributions (RMDs) annually, the owner could take the after-tax amount of the RMDs (or more) and use them to purchase a permanent life insurance policy. At the owner’s death, the beneficiary would receive the death benefit income-tax-free by the beneficiary.  Instead of receiving IRA and/or qualified plan assets that must be distributed and taxed within 10 years, beneficiaries would get the full value of the income-tax-free death benefit. If the life insurance purchase is structured so that the policy is owned by an irrevocable trust, the death benefit also can be estate-tax-free.

It’s important to realize that taxes may matter more after retiring than before and if the goal in retirement is to preserve your wealth for yourself and the next generation, understanding tax risk and taking steps to reduce it, is a very important component of a complete retirement plan. As with any planning strategy, you should discuss the many details and nuances with your advisors and carefully weigh the pros and cons.

If you would like to learn more about any of the above strategies, please don’t hesitate to reach out to us.

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