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A few months ago, the US House of Representative passed the SECURE (Setting Every Community Up for Retirement Enhancement) Act. Subsequently, the legislation is expected to pass in the Senate. One of the main provisions of the SECURE Act is to place restrictions on inherited (or Stretch) IRAs. In this article, four experts weigh in on the pros and cons of the SECURE Act provision to limit inherited IRAs.
Table of Contents
The Good, The Bad, And The Bottom Line Of The SECURE Act
Allow deductible IRA contributions to be made past the age of 70.5 (America's workforce is aging)
Postpone Required Minimum Distributions from 70.5 to 72 (Graying of America's workforce)
Create tax credits to incentivize more small businesses to create retirement plans for their workers and allow multi-employer plans which will lower costs
Eliminate the Stretch IRA for non-spouse beneficiaries (This hurts your kids and grandkids and reduces financial security). On a $1,000,000 IRA balance left to a 45-year-old adult child the difference between utilizing the stretch IRA provision vs the new 10-year mandatory distribution that accelerates the income taxes is approximately $2,000,000 of LOST financial security for the adult child. Talk about reducing financial security – math is linear so a $100,000 IRA balance left to a 45-year-old now loses about $200,000 of tax benefits over the adult child's life expectancy.
Introduces annuities to 401(k) plans: President Obama went to great lengths to insure that Americans didn't get purchasing high fee, low return investments. Will Congress inadvertently open up the flood gates to allow annuity salesmen and their companies to dilute peoples future retirement plans by invading workspace 401(k)s. We hope not.
The Bottom Line:
Our entitlement systems can't be supported (age wave demographics) and Congress is going to do whatever they need to do behind the scenes to address the problem by making money grabs below the radar.”
Craig Bolanos, President and CEO, Wealth Management Group
Review Options With A Tax Planner Or CFP To Ensure Beneficiary Elections Are Up To Date
“Concerns about the SECURE Act are overblown. Over 20 years, the amount of
clients I've worked with who have used a stretch IRA versus those clients that were 70 1/2 and wanted to delay their RMD…it's not even a blip on the radar. If the legislation passes, before it goes into effect, clients will want to review their options with a tax planner or CFP to ensure their beneficiary elections are up to date and still the best option. Sure, that small group of wealthy will have to find another tax-efficient way to pass an estate to their heirs, but multiple planning opportunities will still exist.”
Tony Matheson, CFP, Founder and Wealth Advisor, Matheson Financial Partners LLC
The Issues And Some Planning Techniques
“The primary provision in the Act that would affect estate planning is the restriction on so-called “stretch” IRAs for non-spouses. Currently, when a non-spouse inherits an IRA, he or she must take required minimum distributions (RMDs), and pay any corresponding income tax, little-by-little over his or her life expectancy. For younger beneficiaries, this can result in income tax deferral for several decades. Generally, the new Act would limit the deferral period for inherited IRAs (and other qualified plans) to ten years. At the end of the ten years, any assets remaining in the account would need to be distributed to the beneficiary and (except in the case of a Roth IRA) would be subject to income tax at that time.
There are exceptions. The ten-year rule would not apply to a disabled or chronically ill beneficiary, to anyone less than ten years younger than the IRA owner, or to a child of the owner who has not reached the age of majority (18 in most states).
However, there would be no exception for underage relatives other than IRA owner’s children. Therefore, for example, if an infant grandchild inherits an IRA, the new law would require distribution of the account to the grandchild before he or she is even a teenager.
The new Act would wreak havoc for so-called “conduit” trusts. Conduit trusts have been used by IRA owners to ensure that the bulk of the inherited IRA is preserved for the beneficiary over the long haul. Any required minimum distributions (RMDs) that are distributed from the IRA to the conduit trust are then passed by the trust to the beneficiary; however, the beneficiary does not have any right to withdraw additional account assets. Under the new Act, the trust would blow up after year ten, when the entire account would be distributed to the beneficiary.
Going forward, IRA owners should consider using accumulation trusts instead. Accumulation trusts permit distributions from an IRA, including RMDs, to be preserved for the beneficiary inside the trust. So, although the new Act would require the entire IRA to be distributed to the trust within ten years, the assets could be held in trust for the beneficiary for as long as the terms of the trust dictate. However, an accumulation of trust would not prevent income tax from being assessed as distributions are made from the IRA to the trust.
Income tax planning for IRAs will become more complicated. Will it be better for the beneficiary to withdraw portions of the account each year or to wait until the ten-year deferral period expires? The answer will differ depending on the beneficiary’s circumstances, including but not limited to the beneficiary’s other income and deductions in each year. Using trusts may provide an additional layer of complication, because trusts are subject to harsher income tax brackets than individuals, with the highest rates kicking in at just $12,751 of income.
The new Act will encourage IRA owners to leave all or part of their accounts to or in trust for charity. To the extent a qualifying charity inherits an IRA outright, there is no income (or estate) tax. Alternatively, an IRA owner may leave the IRA to a Charitable Remainder Trust (CRT), which would act as a stretch IRA, even under the new rules. A non-charitable beneficiary, such as a child, would receive annual payments from the CRT over his or her lifetime (or a pre-determined period of years), with income tax assessed as the payments are made. Whatever remains in the account upon the child’s death (or the expiration of the term of years) would pass to one or more charities of the owner’s choosing tax-free.”
Scott Goldberger, Trusts and Estates Principal, Kaufman Rossin
Go Back To The Table For Estate Planning
“Getting rid of the Stretch IRA will require investors to reevaluate their estate planning tactics. A benefit of this act is that it will get investors to go back to the table for estate planning. Far too many investors do estate planning once in their life and neglect it for years to come. This is a great opportunity to get people to look over their plan and bring it up to date. The problem is that changing such a long-term policy (retirement = long term for beneficiaries) means that people may opt for other preferred vehicles instead, in fear of change on the horizon once there is a pendulum swing or change of representatives. One major issue is that if an inheritor is a high-income earner, the SECURE Act may force them into the highest tax bracket by forcing them to expedite their distributions. One technique could be to utilize the assets instead and purchase permanent life insurance to pass on the wealth. If properly
structured, the benefit may be tax-free.”
Thiago Glieger, Private Wealth Manager, Risk Management Group
The SECURE Act was passed in the House of Representatives with an astounding 417 to 3 vote. Seeing as there is tremendous bipartisan support for the bill, undoubtedly this piece of legislation will become law in the not-too-distant-future.