The Secure Act affects your retirement planning
What is the Secure Act?
This year the House of Representatives passed the Setting Every Community Up for Retirement Enhancement Act, known as the Secure Act. The purpose could help Americans save for retirement, unfortunately, Individual Retirement Accounts, 401(k)s, and Roth IRAs will have their value reduced. Waiting for Senate approval, the Secure Act gives non-spouse beneficiaries 10 years to pay out all the money of an IRA. The effect to beneficiaries – a huge tax hit for distributions. This could place beneficiaries in a higher tax bracket.
For example, Susie who is 40 years old inherits a $1,000,000 IRA. Under the Secure Act, she must now take $100,000 at best each year. This will increase her annual income by $100,000. She could lose a significant amount of the payouts to taxes depending on the state she resides.
One of the main problems with the Secure Act is eliminating the Stretch IRA. Congress wants their money. Unfortunately, the Secure Act could undo years of retirement planning.The Stretch IRA has been a significant benefit to estate plans. The Secure Act will soon cause the Stretch IRA to become a myth.
What is the Stretch IRA?
The Stretch IRA is not a financial planning tool. You cannot invest inside of it. Many financial professionals and estate attorneys use this common strategy. It takes the IRA assets and potentially allows the beneficiary to “stretch” the IRA over multiple generations. If you are the owner of a traditional IRA, you are required to take minimum distributions (RMDS) starting at age 70 ½. If you inherit an IRA, you will be required to take minimum distributions based on your life expectancy, according to the IRS. As a result, you can extend the tax deferred status of an inherited IRA that passes to a beneficiary that is not the spouse. This continues the IRA’s tax deferred growth.
Here is an example:
Bill (IRA Owner) has a traditional IRA worth $1,000,000 when he dies.
Travis (Son and only child of Bill) age 30 with a life expectancy of 84.5 will only have to take a Required Minimum Distribution (RMDS) of around $18,000 per year. The rest grows tax deferred.
Similarly, if the IRA owner names a granddaughter instead of the son as beneficiary, then the required minimum distributions (RMDS) are less. This extends the IRA. The remaining sum of the IRA will continue to grow tax deferred throughout their grandchild’s lifetime.
Who is at Risk?
The Stretch IRA strategy commonly used by affluent retirees. They know their spouses have enough money, and want to extend the wealth to their family, leaving a legacy. Large IRAs will feel this impact. Many affluent individuals have used Trusteed IRA’s to shelter this strategy and control distributions.
Definition of a Trusteed IRA?
An IRA names a trust as beneficiary, and at death of the IRA owner the assets are placed into the trust. Placing IRA assets into trust can offer many significant benefits. A Trusteed IRA offers protection, control of a trust, and the tax benefits of an IRA account. This provides the IRA owner flexibility and authority over how the wealth is spent for future generations. It creates family harmony.
In the past, beneficiaries had full control of the inheritance of an IRA. With the Trusteed IRA, the IRA owner can control the amounts of how much the beneficiary distributes.
Here are a few other benefits of implementing a Trusteed IRA:
- Preservation of assets- IRA assets are not distributed prematurely.
- Sudden Wealth- Beneficiaries are limited from completely depleting their entire inheritance immediately.
- Mixed Marriages- Your children won’t be cut out of their inheritance from the wealth you built if your spouse remarries.
- Disability protection- If Trusteed IRA is in place upon owner’s incapacitation it can step in for use and direction of assets without court intervention.
- Protection from creditors- Inclusion of a spendthrift clause in trust provisions can protect assets from potential claims of creditors.
The Secure Act will significantly impact the benefits of using a Trusteed IRA. Therefore, the Trusteed IRA will also become a myth. IRA assets placed in trust are no longer subject to minimum distributions requirements. If you have a Trusteed IRA you can wait to take distributions until the tenth year and take advantage of compounding interest. All the assets are delivered in the tenth year. The non-spouse beneficiary will receive a huge amount, but will be taxed in the highest brackets. Everyone needs to understand how this will impact their estate plan and family.
What are your options?
Although the Senate has not approved the Secure Act, the likelihood of the passing of the Secure Act remains only a matter of time.
A possible consideration:
A strategy can be to withdraw some of the IRA assets and purchase life insurance. Then, take the policy and place it into trust for your beneficiaries. No taxes are paid on the value of the policy. As a result, the IRA owner has control because there are not required minimum distributions or complex tax rules. The IRA owner also receives the benefits of a trust. Name an individual or a corporate trustee to manage the trust assets providing yourself peace of mind.
Finally, the Secure Act will require individuals to find alternative strategies. Speak with an estate professional about the different tax efficient planning that can be done.