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Retirement Planning Post-SECURE Act
For those of you counting on your beneficiaries stretching out the distributions from the IRAs they inherit from you, think again. The SECURE Act was passed into law on December 19, 2019, eliminating this popular estate planning strategy for most beneficiaries.
In order to understand how the SECURE Act affects anyone who inherits an IRA, 401(k) or other qualified retirement account, you must first understand how the law used to work. Under the old law, anyone inheriting a retirement account (I’ll call them collectively IRAs from now on) could stretch the distributions from the account over the course of their lifetime under an IRS actuary table.
By only taking the Required Minimum Distribution (RMD), the rest of the IRA continues to grow tax deferred and income taxes were minimized.
The SECURE Act eliminates, for most IRA beneficiaries, the ability to stretch the distributions of the inherited IRA over the course of their lifetimes. Instead, beneficiaries must withdraw the entire balance by December 31st of the tenth anniversary date of the death of the account owner.
Suppose that Dad dies on July 1, 2020 naming Son, age 50 as the beneficiary to his IRA. On January 1, 2021 the IRA is worth $600,000. Under the old law, Son must take an RMD of $17,543. This is based on a factor of 34.2 which represents the number of years (Son’s life expectancy under IRS Tables) that Son would have had to withdraw the entire IRA balance.
Under the new law, let’s assume the same facts. Son must withdraw the entire balance of Dad’s IRA on or before December 31, 2030. Instead of 34 years, Son now has 10 years to withdraw the entire IRA balance. Instead of an annual distribution, however, Son can choose to wait until that last day to withdraw the entire account balance.
The SECURE Act therefore reduces the opportunity for tax deferred growth (in my example 24 years worth), increases income taxes on the beneficiaries since the larger distributions will push the beneficiary into a higher income tax bracket, and likely result in less money being distributed overall out of the account. The government gets more while the beneficiaries get less.
But all is not lost under the SECURE Act. What you don’t want to do is mindlessly fill in your beneficiary forms. The best course of action is to visit with a qualified estate planning attorney who understands not only the nuances of the SECURE Act, but of income taxation of trusts.
Consider a Retirement Plan Trust. Recall that if Son inherits a $600,000 IRA and withdraws approximately $100,000 annually until the account is exhausted and assume that Son is not only in a high federal income tax bracket but also pays state income taxes. In Minnesota, for example, the highest marginal state income tax rate is 9.85%. The combined federal and state income tax rate may be as high as 46.85%.
How can one potentially use a trust to reduce these taxes? There’s something known as a see-through accumulation trust that can be named as the beneficiary to the IRA. There’s five requirements to qualify the beneficiary of the trust as the beneficiary of the IRA, but so long as those requirements are met then the IRA will have the ten year distribution rule under the SECURE Act.
In my example, assume that the trustee of a Florida Retirement See-Through Accumulation Trust withdraws $100,000 but instead of distributing it out to Son, he accumulates it for 2021. Because Florida has no state income tax, the trustee pays the federal tax of approximately $35,300. If instead that same amount was distributed to Son, he would have paid combined state and federal taxes of $46,850. The trustee distributes the principal of the trust the next year, with no more taxes due as it is a principal distribution.
While my example is theoretical and we will have to wait to see how the state departments of revenue react, I believe that my theory is arguable.
There are many other strategies one might consider under the SECURE Act to maximize the inheritance for your family and achieve your goals. In fact, I’ve created a webinar discussing the SECURE Act in full as well as strategies that you can implement.