The SECURE Act which became law on December 20, 2019 eliminated a popular estate planning technique for many individuals. The new law enjoyed a rarity in Washington, bi-partisan support and was passed without much haggling (in DC there is ALWAYS haggling, but by recent standards this was relatively low). The new plan which is an acronym for Setting Every Community Up for Retirement Enhancement Act of 2019 had numerous provisions and many of the favorable ones are listed below:
- a) made it easier for small businesses to establish “safe harbor” retirement plans which are less expensive and easier to maintain,
- b) allows for part time employees to participate in employer sponsored retirement plans,
- c) changes the age for required minimum distributions from age 70 ½ to age 72,
- d) allows for IRA contributions to continue indefinitely,
- e) allows for 401(k) plans to offer annuities and,
- f) required that all non-spouses who inherit an IRA must deplete that account completely within 10 years.
Points A-E were all very positive points for individuals and employers alike, but all of them come with a cost and a way was needed to pay for these and that is where point F comes in. Prior to the passage the SECURE Act a non-spouse who inherited an IRA could take the required minimum distribution out based on that individual’s age. For example, Don has an IRA with $500,000 in it (or other qualified retirement plan) and dies at age 85. His son, Sam, age 50 now inherits that IRA. Prior to the passage of this law Sam could take out the required minimum based on his age (at age 50 he would divide that amount by his life expectancy as published by the IRS of 34.2 years) which is $14,619. The remaining balance would continue to grow tax-deferred until next year when the same calculation is done and so on for the rest of Sam’s life. This was a very popular estate planning technique due to the fact that the majority of the asset is being allowed to grow tax-deferred and that when Sam’s required distributions increased later in life then presumably his tax bracket has decreased when compared to when he was at peak earnings in his 50s. I understand that the Stretch IRA was a tax loophole, but it was one that has been used in many estate plans for being a tax efficient manner in which to transfer qualified plan assets. Now enter the SECURE Act in December of 2019.
The SECURE Act states that non-spouse beneficiaries must take the entire amount by the end of 10 years. Now why did they do this? The simple answer is, MONEY! By accelerating the timeframe during which the money has to be received they also simultaneously accelerate the tax revenue generated off the accelerated withdrawals from the IRA. Keep in mind that this is also occurring most likely when the non-spouse beneficiary is at the top of his income earnings and thus creating a larger tax on the withdrawal. So now the question becomes what do you do with that IRA that you were going to leave to your children as the only money you take from it was the amount that the IRS mandated.
Ed Slott, widely recognized as the IRA guru suggested in his February, 2020 article that life insurance could be an attractive alternative to the now defunct Stretch IRA. Basically what you do is take out either in one year, over a period of years or even over your lifetime (depending upon a variety of factors such as age, tax status, health, marital status, anticipated income needs, etc.) the value of that IRA and purchase a large life insurance policy. You would recognize the taxes on that withdrawal so you need to do this in the concept of a complete financial plan. When you ultimately pass away your beneficiaries would receive the life insurance proceeds income tax free. So, the question becomes when should you start looking at this option and the answer is the younger the better. Many people know early on into (or maybe even prior to) retirement if they are going to need their IRA to help fund their retirement. So, if you know early on that your IRA is not going to be needed to fund your lifestyle in retirement than you might want to consider using life insurance as an alternative for your beneficiaries. Please note that this needs to be done as a part of a holistic plan as there are many considerations that I can not cover in this article.
It is often said that the only things that you can depend on is death, taxes and change. Well, the SECURE Act hit all three. For some the impact will be negligible, for others it will be very significant. How do you know if you should do this or not, start with looking at your financial plan and see what happens to it if your IRA was not included in the plan. If your lifestyle was dramatically altered then this probably is not the best technique for you, but if your lifestyle is unaffected then maybe it warrants a discussion with your financial advisor.
For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.