SECURE Act Kills Stretch IRA Strategy, Limiting Wealth Transfer to Your Heirs, But Workaround Options Can Provide Relief
By Len Garza, Esq.
Some individual retirement account holders have been wrestling with the impact of retirement legislation that snuffed out their attempt at a tax-advantageous inheritance for their loved ones.
The Setting Up Everyone for Retirement (SECURE Act) is a bipartisan bill passed by Congress in 2019 and that went into effect in January 2020 to help Americans save for retirement. While the bill did just that, it fell short on protecting the rights of individuals with hefty IRA holdings to transfer wealth to their heirs.
What’s Good for You Kills Benefits for Your Heirs
The bill does a lot of good things for your retirement, but not much good for your heirs. The SECURE Act does make it easier for small businesses to offer their employees 401(k) plans by providing tax credits; allowing retirement benefits for long-term, part-time employees; raising the required minimum distribution (RMD) age to 72 from 70 1/2 and removing maximum age limits on retirement contributions formerly capped at age 70½.
But, the Stretch IRA, an estate-planning strategy that allowed individuals to transfer monies to non-spousal heirs for life, went on the chopping block to help subsidize the estimated $15.7 billion price tag that comes with these changes.
Your Estate Plan: Not One and Done
If there was ever a reason why you must not let your estate plan remain untended and collecting dust on a shelf or in a drawer, the enactment of the SECURE Act is one of them. Laws affecting your estate plan change frequently (Think back to the 2017 Tax Cuts and Jobs Act). Failing to account for these changes in your estate plan could wipe out the benefits intended when your plan was originally prepared. That’s why turning to your financial advisor and estate attorney to review and update your plan to adjust for changes can make all the difference in safeguarding the inheritance you intended for your heirs.
In the past, stretch IRAs were popular as a financial strategy that gave non-spouse heirs the opportunity to take out inherited IRA distributions throughout their own life expectancies. Congress saw this as a loophole used by the wealthy. In fact, though, the strategy was helpful to all individuals who decade-upon-decade diligently socked money away in their IRAs and wanted to pass on as much of their savings as possible to their loved ones.
Using the stretch IRA, they selected non-spouse beneficiaries (the most frequent being their children or grandchildren) who were in lower tax brackets and could receive distributions over their lifetimes. This “stretched” distribution timeframe allowed the undistributed IRA funds to grow substantially for a longer time as it allowed beneficiaries to withdraw monies in amounts and at times of their own choosing. The younger the beneficiary, the longer the timeframe for the IRA to grow—and, the more beneficial the stretch strategy.
The New Rule: Ten Years and Out
But, thanks to the SECURE Act, that stretch strategy is dead. Gone is the ability of some beneficiaries to accept distributions. Out also is the opportunity for your beneficiaries to spread the tax liability of their distributions over their life expectancy. Now, they must exhaust all IRA funds within 10 years.
In addition to these changes the SECURE Act created a new type of beneficiary, the eligible designated beneficiary (EBD). To qualify as an EBD, your named beneficiary must be a minor, disabled, chronically ill or not more than 10 years younger than you, as the deceased IRA owner. That being said, only minors who are your children can qualify as an EBD, impacting the minor grandkids who were frequently beneficiaries of the Stretch IRA strategy.
EBDs can still use the Stretch IRA rules that existed before the SECURE Act, as the beneficiary has discretion over when to take withdrawals during the 10-year window. But once the minor reaches majority (18 or 21, depending on the state), the 10-year rule kicks in.
New Laws, New Strategies
As disheartening as this news may be, the reality is that you don’t have to sit idly by and accept Uncle Sam’s forced 10-year payout schedule. Your financial advisor and estate attorney and recommend appropriate workaround strategies to help you navigate these uncharted waters.
Here are some initial strategies that can help minimize the taxman’s impact on your IRA in this new post-SECURE Act:
Identify your beneficiaries. It makes sense to carefully evaluate whether any of your potential beneficiaries would qualify as an EBD. If so, you should talk with your advisors about using EBDs as a strategy.
Create a Charitable Remainder Trust. If you’re charitably inclined, you still may be able to simulate a stretch IRA by creating a charitable remainder trust (CRT). You put assets in the CRT and provide income for beneficiaries for a set timeframe or their life span. Once that term is completed, the remainder of the principal goes to charity. The CRT can thus provide a stream of income to beneficiaries in much the same way as the Stretch IRA. You can also fulfill your charitable goals. The remaining assets are dispensed to charity upon completion of the distribution term.
Use an Irrevocable Life Insurance Trust. You could use IRA distributions, such as required minimum distributions (RMDs), to pay for premiums for a life insurance policy. When you die, the policy would provide income-tax-free death proceeds to your beneficiaries. A fringe benefit: The IRA balance that passes to your beneficiaries will have a lower balance because of the monies used for insurance premiums.
If you are concerned about estate taxes, an irrevocable life insurance trust (ILIT) removes the policy from your estate. Two factors important for your consideration, however, are that you 1) must be insurable to use this strategy and 2) if you implement this strategy later in life, the premiums can be very expensive. Depending on your health and the cost of the premiums, this strategy may be too expensive to make sense for you.
Initiate a Roth conversion. Traditional IRAs, which are funded with pre-tax dollars, can be converted into Roth IRAs, which are designed to hold after-tax contributions. From an income tax perspective, this could be an option for those looking to leave their inheritance in IRA money, while avoiding a hefty tax bill. You can convert some of your IRA to a Roth IRA by transferring funds a little at a time over several years. This way, you can keep your income from creeping into a higher bracket. Your beneficiaries will still be stuck with the 10-year rule after death, but at least there will be no tax on amounts they withdraw, so all the income accrued while in the Roth will be tax-free to them.
Take Advantage of Qualified Charitable Distributions. Another way to bring down your taxable IRA balance during your lifetime is to take advantage of qualified charitable distributions (QCDs). QCDs allow you to make charitable contributions through direct transfers from your IRA. Those IRA withdrawals are excluded from your income, lessening the tax impact for both you and your beneficiaries. QCDs can also be used as your annual RMD, satisfying that requirement and creating a big tax benefit. One caveat: Even though the age for RMDs was changed to age 72, the age for QCDs remains at 70-1/2.
Turn to taxable investment accounts alternatives. Beneficiaries typically don’t pay capital gains on inherited investment accounts, which make them an attractive alternative to an IRA inheritance. Heirs would only have to pay taxes if they sell the investments after the account is transferred, but a likely stepped-up cost basis can lessen your tax hit.
Use Disclaimers in Your Estate Planning Documents: Using disclaimer provisions in your estate plan documents (e.g. your wills, trusts, and beneficiary designations of your IRAs and retirement plans) can give you the flexibility you need to deal with the uncertain future.
Disclaimers provisions allow your named beneficiary to say they do not want the money and to give it to the person next in line. Why would a beneficiary do this? Say, for example, your surviving spouse does not need all of the funds, they can accept a part and pass down the remainder to a subsequent (a/k/a contingent) beneficiary, with potential advantageous tax consequences.
If you incorporate disclaimer provisions in your estate planning documents, your surviving spouse has up to nine months after your death to consider how much to keep and how much to disclaim to your children. It is critical to talk with your estate planning attorney to make sure you correctly utilize this strategy.
At The Nan Gallagher Law Group we know that you want your children and grandchildren to benefit from the savings you’ve accumulated during your lifetime. We are committed to helping you achieve this goal by reviewing your estate plan with you at regular intervals and making the necessary adjustments to fulfill your wishes.
Call us at 973.889.8494 to make sure that as laws inevitably change, you have all the right strategies in place to ensure the legacy you leave to your future family generations is exactly the one you intended.
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