In December, Congress passed the SECURE Act, and the president signed it into law. The SECURE Act, which took effect Jan. 1, changes many of the rules surrounding individual retirement accounts and other retirement accounts.
There are a few important provisions you should know. First, the SECURE Act pushes back the required minimum distribution age from 70 1/2 to 72. This means that whether you like it or not, you will have to take a percentage of your pretax dollars out of your IRA at 72 instead of 70 1/2. Second, you can now make contributions to your IRA after 70 1/2 if you have earned income. Third, and most importantly, the SECURE Act has dealt a death blow to “Stretch IRAs.” This means that any non-spouse who inherits an IRA must pay all of the account’s required tax within 10 years of death versus being able to stretch the required minimum distributions over their lifetime.
The end of the “Stretch IRA” can have a dramatic effect on tax planning, estate planning and legacy planning. Estate plans, financial plans and tax strategies should be reviewed in this new post-SECURE Act world to ensure your family and loved ones don’t have a huge tax bill. Chances are that is not the legacy you want to leave.
Here are three categories of financial strategies to help you and your family mitigate unnecessary tax on your retirement accounts.
Roth Conversions And Tax Bracket Management
The Tax Cuts and Jobs Act emphasized analyzing tax brackets on an annual basis. This is because taxes from 2018-2025 are essentially “on sale” due to marginal tax brackets being lowered during that time frame. Post-SECURE Act, this becomes even more of a priority.
The idea is, near the end of the year, to figure out how much money should be pulled from your pretax accounts, pay the income tax and put that money into a Roth account, which can grow tax-free. By engaging in conversions from age 60 until death (let’s say at age 87), there would be 27 years to pay the tax on those pretax accounts, versus relying on the 10 years the SECURE Act allows for inherited IRAs.
There are even more creative strategies for married couples where you could name your spouse as only a half beneficiary of the IRA money and name your kids as the other half beneficiary. This would start one 10-year clock for the kids, but then if the surviving spouse lives for another 10 years, that would buy another 10-20 years of time to move money from the IRA instead of the mandated 10-year window.
Would you rather leave money to the government or to a church or charity of your choice? Depending on how you answer that question, there may be strategies where you could leave a portion of your pretax IRA accounts to charities, to minimize taxes, while still leaving a portion to your beneficiaries. These strategies were used quite a bit in the past when the estate tax exemption was lower. Specialized trusts like charitable remainder trusts can minimize tax, while maximizing the benefits of your retirement accounts for your beneficiaries and charities of your choice.
Life Insurance Strategies
“Buy term and invest the rest.” You may have heard that phrase. If you are looking for cheap insurance when you are young, that may make sense. However, when it comes to retirement planning, many people need to rethink their view of life insurance. Looking at permanent life insurance as a tool that can be utilized may make sense. There are three life insurance strategies one could use post-SECURE Act.
1. The Roth Conversion IRA Hedge Strategy: With the IRA hedge strategy, you would look to using a combination of term and permanent insurance to cover the taxes while engaging in Roth conversions over time. For example, if you had a large IRA and were engaging in Roth conversions annually, there still would be a tax on the remaining pretax accounts. By using insurance to cover that hedge, you’ve leveraged your assets to leave more of a tax-free legacy to your beneficiaries.
2. The IRA Relocation Strategy: This strategy looks to relocate those pretax IRA dollars somewhere else, using life insurance as a way to create more “bang for your buck.” In fact, this was the go-to strategy when estate taxes were more of an issue. Families using this method would move money from the IRA, pay the tax, and use that money to purchase life insurance in a trust using an irrevocable life insurance trust, or ILIT. Post-SECURE Act, this strategy makes sense again, but the trust does not have to be an ILIT where you have to give up control; it could be an asset protection trust.
3. The IRA Annuity Legacy Strategy: This plan involves annuitizing your retirement account, with the money coming out over time (longer than the 10 years of the SECURE Act, providing more time to ease the tax burden). A portion of the annuity payments would be used to purchase permanent life insurance that can then go to your beneficiaries tax-free.
Planning In The Post-SECURE Act World
The SECURE Act is here. We cannot change that. It will affect inherited IRAs for anyone who passes away after December 31, 2019. But with proper planning, you can mitigate some of the effects of the act and secure the futures of your beneficiaries, instead of securing more taxes for Uncle Sam.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.