The majority of many people’s wealth is saved gradually from a lifetime of work and stored in their IRAs. For most of these people, a primary goal is to leave their IRAs to their children, says a recent article from Think Advisor titled “Three Replacements for Stretch IRAs.” The ability to distribute IRA wealth over years, and even decades, was eliminated with the passage of the SECURE Act.
The purpose of the law was to add an estimated $428 million to the federal budget over the next 10 years. Of the $16.2 billion in revenue provisions, some $15.7 billion is accounted for by eliminating the stretch IRA.
Existing beneficiaries of stretch IRAs will not be affected by the change in the law. But going forward, most IRA heirs—with a few exceptions, including spousal heirs—will have to take their withdrawals within a ten-year period of time.
The estate planning legal and financial community is currently scrutinizing the law and looking for strategies that will minimize the tax consequences of this new rule. Here are three estate planning approaches that are emerging as front runners:
Roth conversions. Traditional IRA owners who wished to leave their retirement assets to children may be passing on big tax burdens now that the stretch is gone, especially if beneficiaries themselves are high earners. An alternative is to convert regular IRAs to Roth IRAs and take the tax hit at the time of the conversion when the IRA owner is presumably in a lower tax bracket than their working children.
There is no guarantee that the Roth IRA will never be taxed, but tax rates right now are relatively low. If tax rates go up, it might make converting the Roth IRAs too expensive.
This needs to be balanced with state inheritance taxes. Converting to a Roth could reduce the size of the estate and thereby reduce tax exposure for the estate as well.
Life insurance. IRA owners can take distributions from an IRA to pay for a new life insurance policy to be distributed to their beneficiaries. When the beneficiaries receive the death benefit, it will not be included as the beneficiary’s income. This is being widely touted as the answer to the loss of the stretch, but like all other methods, it needs to be viewed as part of the entire estate plan. While this method is not a new strategy, it may be used more frequently due to the elimination of the stretch.
Charitable Remainder Trusts (CRT). The IRA could be used to fund a charitable remainder trust. This allows the person setting up the trust to establish an income stream for heirs with the IRA assets, and then have any amounts remaining upon the heirs’ deaths going to a named charity. The trust can grow assets tax-free. There are two different ways to do this: a charitable remainder annuity trust, which distributes a fixed annual annuity and does not allow continued contributions, or a charitable remainder unitrust, which distributes a fixed percentage of the initial assets and does allow continued contributions.
Speak with your estate planning lawyer about what options may work best in your unique situation.
Reference: Think Advisor (Jan. 24, 2020) “Three Replacements for Stretch IRAs”