Alternatives for Stretch IRA Strategies

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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”

Unintended Kiddie Tax Change Fixed in the SECURE Act

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Families were hurt by a change in the kiddie tax that took effect after 2017, but they’ll be able to undo the damage from 2018 and 2019 now that a fix has become law. The SECURE Act contains a provision that fixed this unintended change, as reported in the San Francisco Chronicle’s recent article, “Congress reversed kiddie-tax change that accidentally hurt some families.”

The kiddie tax was created many years ago to prevent wealthy families from transferring large amounts of investments to dependent children, who would then be taxed at a much lower rate than their parents. It taxed a child’s unearned income above a certain amount at the parent’s rate, instead of at the lower child’s rate. Unearned income includes investments, Social Security benefits, pensions, annuities, taxable scholarships, and fellowships. A child’s earned income, which is money earned from working, is always taxed at the lower rate.

The Tax Cuts and Jobs Act of 2017 changed the kiddie tax in a way that had severe consequences for military families receiving survivor benefits. Instead of taxing unearned income above a certain level—$2,100 in 2018 and $2,200 in 2019—at the parent’s tax rate, it taxed it at the federal rate for trusts and estates starting in 2018.

Hitting military families with a 37% tax rate that starts at $12,750 in taxable income is unthinkable, but that’s what happened. Low and middle-income families whose dependent children were receiving unearned income, including retirement benefits received by dependent children of service members who died on active duty and scholarships used for expenses other than tuition and books, were effectively penalized by the change.

Under pressure from groups representing military families and scholarship providers, Congress finally added a measure repealing the kiddie tax change to the SECURE Act, which seemed as if it was going to be passed quickly in May. The bill was stalled until it was attached to the appropriations bill and was not passed until December 20, 2019.

There is a specific provision in the bill: “Tax Relief for Certain Children” that completely reverses the change starting in 2020. It also says that subject to the Treasury Department issuing guidance, taxpayers may be able to apply the repeal to their 2018 and 2019 tax years, or both.

The IRS has not yet issued guidance, but the expectation is that amended returns will be required if a taxpayer elects to use the parents’ tax rate for that year.

Some parents whose children have investment income may be better off using the estate-tax rate for the two years that it is in place. In 2019, those trust brackets may actually allow more capital gains and dividends to be taxed at 0% and 15% rates than by using the parents’ rates.

If you were hit with the kiddie tax, talk to an estate planning attorney, tax attorney, or tax advisor to see if you might benefit from the SECURE Act.

Reference: San Francisco Chronicle (Jan. 20, 2020) “Congress reversed kiddie-tax change that accidentally hurt some families”

How Does the SECURE Act Change Your Estate Plan?

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The SECURE Act has made big changes to how IRA distributions are passed on after a participant’s death. Anyone who owns an IRA, regardless of its size, needs to examine their retirement savings plan and their estate plan to see how these changes will have an impact. The article “SECURE Act New IRA Rules: Change Your Estate Plan” from Forbes explains what the changes are and the steps that need to be taken.

Some of the changes include reviewing wills and trusts which include provisions creating conduit trusts that had been created to hold IRAs and preserve the stretch IRA benefit, while the IRA plan owner was still alive. Existing conduit trusts may need to be modified before the owner’s death to address how the SECURE Act might undermine the intent of the trust.

It may be necessary to rethink and possibly completely restructure the planning for IRA accounts. This may mean changing the beneficiary of an account to a charity, and possibly using life insurance or other planning strategies to create a replacement for the value of the charitable donation.

Another alternative may be to pay the IRA balance to a Charitable Remainder Trust (CRT) on death that will stretch out the distributions to the beneficiary of the CRT over that beneficiary’s lifetime under the CRT rules. Paired with a life insurance trust, this might replace the assets that will ultimately pass to the charity under the CRT rules.

The biggest change in the SECURE Act being examined by many estate planning and tax planning attorneys is the loss of the “stretch” IRA for beneficiaries inheriting IRAs after 2019. Most beneficiaries who inherit an IRA after 2019 will be required to completely withdraw all plan assets within ten years of the date of death.

One reason why Congress enacted this law was to generate tax revenues that would become collectible far sooner. In the past, the ability to stretch an IRA out over many years, even decades, allowed individuals to pass their tax deferral on significant IRA growth to their family members, which meant that tax revenue due from the assets’ growth could not be collected.

Another interesting change is that there are now no periodic mandatory withdrawals when an IRA is inherited. However, at the ten-year mark, ALL assets must be withdrawn, and taxes paid. Under the prior law, the period in which the IRA assets needed to be distributed was based on whether the plan owner died before or after the RMD and the age of the beneficiary.

The deferral of withdrawals and income tax benefits encouraged many IRA owners to bequeath a large IRA balance completely to their heirs. Others, with larger IRAs, used a conduit trust to flow the RMDs to the beneficiary and protect the balance of the plan.

There are exceptions to the 10-year SECURE Act payout rule. Certain “eligible designated beneficiaries” are not required to follow the ten-year rule. They include the surviving spouse, chronically ill heirs, and disabled heirs. Minor children are also considered eligible beneficiaries during the time that they are minors (as defined by the tax code), but when they reach the age of majority, the ten-year distribution rule then applies to them. For example, a child who has reached the age of majority at 18 must take all assets from the IRA by the time they are 28 and pay the taxes as applicable.

The new law and its ramifications are under intense scrutiny by members of the estate planning and elder law bar because of these and other changes. Speak with your estate planning attorney to review your estate plan to ensure that your goals will be achieved in light of these changes.

Reference: Forbes (Dec. 25, 2019) “SECURE Act New IRA Rules: Change Your Estate Plan”

SECURE Act Means It’s Time for an Estate Plan Review

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The most significant legislation affecting retirement was signed into law on Friday, Dec. 20, 2019. After stalling for months, Congress suddenly passed several bills, as attachments to budget appropriations, as reported by Advisor News’ article “SECURE Act, Signed by Trump, A Game-Changer For Retirement Plans.”

Here are some of the key points that retirees and those planning their retirements need to know:

Changes to Age Limits for IRA and 401(k) Accounts. The age for taking Required Minimum Distributions (RMDs) has increased from 70½ to 72 years. Adding a year and a half for investors to continue deferred growth for retirement gives a little more time to prepare for longer lifespans. The change recognizes the prior limits were arbitrary, and that Americans need to save more.

New Restrictions for Inheriting IRAs. The SECURE Act also enacted strict limitations on the usage of the “stretch” IRA. With few exceptions, Americans who inherit an IRA must now withdraw the money within 10 years of the account owner’s death, along with paying taxes. Some of the exceptions include surviving spouses and minor children. These exempt heirs can still spend down inherited IRA accounts over their lifetime, otherwise known as “stretching” the IRA.

Small Business 401(k)s. The SECURE Act expands access to Multiple Employer Plans, known as MEPs, so that employers with only a few employees can pool resources and share the costs of retirement plans for employees. This will cut administration and management costs, which will ideally allow more small businesses to offer higher-quality retirement plans to their employees.

The law also enhances automatic enrollment and auto-escalation, letting companies automatically enroll employees into a retirement plan at a rate of 6%, instead of 3%. Employers can now raise employee contributions to a maximum of 15% of their annual pay, although workers can opt out of these plans at any time.

Annuities Options. The SECURE Act now allows 401(k) plans to offer annuities as a retirement plan option. Experts have mixed opinions on this. Annuities are a type of life insurance that convert retirement savings into lifetime income. However, fees are often high, and if the insurance company closes its doors, those lifetime income payments may vanish. Under the new law, employers also have what’s called a “safe harbor” from being sued in the event that annuity providers go out of business or stop making payments to annuity purchasers. Being freed from liability may make employers more likely to offer annuities, but that may put 401(k) investors at more risk, say consumer advocates.

529 Plans and Saving for Children. The new law expands 529 accounts to cover many more types of education, such as registered apprenticeships, homeschooling, private elementary, secondary or religious schools. Up to $10,000 can be used for qualified student loan repayments, including for siblings.

Reference: Advisor News (December 23, 2019) “SECURE Act, Signed by Trump, A Game-Changer For Retirement Plans”

Stretch IRA May be Disappearing Soon

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Short of calling your representatives in Congress and hollering, there’s not much any of us can do about a proposed change to the rules that govern stretch IRAs, reports nj.com in the article “Your kid’s inheritance could take a giant tax hit if these bills become law. Thanks, Congress.”

For years, non-spouse beneficiaries who inherit IRAs have had the ability to stretch out required distributions over their lifetimes. That meant that inherited IRAs could say safe and sound out of the IRS’s reach, except for annual distributions that were quite small. If a grandchild inherited the IRA, the wealth stretched even further.

Depending on the final details of the legislation, the only people who will be able to stretch an IRA will be spouses.

Current rules require non-spouse beneficiaries to take required minimum distributions (RMDs) every year over the course of their life expectancy, as per the IRS life expectancy tables. Because they are taken over the lifetime of a younger beneficiary, they can be small. This means the impact of the distribution on the individuals’ income taxes are minimal and the IRA can grow tax-deferred over a long period of time.

Congress is looking for revenue, and the wealth of Americans in IRA accounts is in their sight lines.

First, the House passed the SECURE Act, which says that beneficiaries must completely empty their inherited IRAs within 10 years of ownership. The Senate then passed the RESA Act, which is a little different. It would allow a stretch for the first $450,000 of aggregated IRAs, then anything over that would have to be distributed within five years.

Both bills call for changes to apply to inherited IRAs and inherited Roth IRAs for deaths after December 31, 2019. What’s the bottom line? The Joint Committee on Taxation expects that these changes, if they become law, will yield $15.7 billion—with a “B”—in additional tax revenue through 2029.

The government would eventually get this money anyway, but this speeds things up considerably.

Let’s compare and contrast. An 80-year old woman has a traditional IRA worth $1 million. She dies and her 55-year-old daughter is the primary beneficiary. Under the current rules, the daughter’s first RMD is roughly $35,000. If the 25-year-old granddaughter was the beneficiary, the RMD would be roughly $18,000.

If the account earns an average of 5% annually, under the current rule, the granddaughter would have distributions of some $220,000 over ten years. If she had ten years to take the money out, she’d have about $1.3 million in distribution. Under the current rule, the account would have a $1.3 million balance after ten years, since the principal would continue to appreciate. Under the proposed rules, after ten years, it would be zeroed out.

The forced larger distributions will push heirs into higher tax income brackets. That will be followed by increased Medicare premiums, as heirs retire with higher income. Add to that: higher capital gains rate, from as low to zero to as high as 20%. If that’s not bad enough, it could also trigger the 3.8% net Investment Income tax.

One option is to move funds from a regular IRA to a Roth IRA, assuming the investor meets all the requirements to do so. The Roth IRA distributions would not be taxable (unless those laws change) but that also requires the current owner to pay taxes on funds moved to the Roth IRA.

Another option is to consider a Charitable Remainder Trust (CRT) that names a charity as the IRA beneficiary. Upon the death of the owner, the IRA is distributed to the CRT, and the IRA owner’s heir would receive a fixed percentage of the CRT’s value for the remainder of their lives. When the heir dies, the money in the CRT goes to a charity or charities designated by the IRA owner, when the trust was created.

For now, these are proposed pieces of legislation, but chances are good they will be passed soon. Now is a good time to meet with your estate planning attorney to do what you can to protect your IRA and the stretch IRA of your children’s inheritance.

Reference: nj.com (June 10, 2019) “Your kid’s inheritance could take a giant tax hit if these bills become law. Thanks, Congress”