Prior to the Setting Every Community Up for Retirement Enhancement (SECURE) Act being enacted on December 20, 2019 and implemented on January 1, 2020, Estate Planning Attorneys had a wonderful gift to provide to their clients with significant retirement assets: The “Stretch IRA.”
The Stretch IRA allowed for non-spouses inheriting retirement accounts to “stretch” disbursements over their lifetime allowing for potentially significant tax-deferred growth. With the passing of the SECURE Act, full payout from an inherited IRA is required to take place within 10 years of death of the original account owner, unless a non-spouse qualifies as an “Eligible Designated Beneficiary,” discussed below.
Key Provisions of the SECURE Act
Delayed Required Minimum Distributions (RMDs).
Generally, you must begin taking distributions from qualified retirement plans and IRAs after reaching a certain age. RMDs, which are based on your account balance and life expectancy, had to start in the year after the year you turned 70½, prior to the SECURE ACT. After the passing of the SECURE Act, however, the age requirement extends to age 72, giving you even more time build up your tax-deferred retirement savings.
Previously, you weren't able to contribute to an IRA after age 70½; the SECURE Act removes this age restriction. This enables you to supplement existing retirement plan accounts with IRA contributions if you continue working. For 2022, the annual contribution limit $6,000 if you are younger than age 50, or $7,000 if you are age 50 or older.
It should also be noted that you may be able to deduct 2022 IRA contributions from your taxes. If you (and your spouse, if married) do not have a retirement plan at work, such as a 401(k), you should be able to deduct the full contribution to your traditional IRA on your tax return. Even if you already have a retirement plan, for example, through your job, you may still be able to deduct some, or all, of your retirement contributions, depending on your income. For 2022 IRA contributions, single individuals with a Modified Adjusted Gross Income of $60,000 or less, and joint filers with income of up to $109,000 can deduct their full contribution for the 2022 tax year. Deductions decrease from here and completely phase out once individual income reaches $78,000, or $129,000 for joint filers.
To encourage the use of annuities in retirement planning, the new law requires 401(k) plan administrators to provide annual “lifetime income disclosure statements” reflecting annuity options, and participants who acquire annuities are provided with more flexibility than in the past, including plan portability (e.g., switching jobs and participating in a new 401(k) plan).
As noted above, the SECURE Act cracks down on stretch IRAs that allowed beneficiaries (other than a spouse) to spread out RMDs over their life expectancies. Under the SECURE Act, funds from inherited accounts must be distributed to beneficiaries (absent limited exceptions) within 10 years of the account owner's death. This provides a finite end to stretch IRAs and reduces their effectiveness as an estate planning tool. The limited exceptions apply to surviving spouses; minor children up to the age of majority; disabled and chronically ill individuals; and those not more than 10 years younger than the IRA owner, as long as they remain qualified beneficiaries. This can result in significant income tax on a beneficiary. Suppose, for example, a retirement account owner leaves an account with a $300,000 balance to a beneficiary that is required under the SECURE Act to be paid out in 10 years from the death of the account owner. If such a beneficiary procrastinates until the end of the 10-year period to withdraw the entire benefit, the entire distribution would be counted toward the beneficiary's taxable income, which can easily shift an individual to a higher income tax bracket. With this situation, the government is going to get a hefty chunk of an asset that you have worked your whole life to establish and which you intend for your loved ones to inherit.
Strategies After the SECURE Act
Because of the SECURE Act's impact on estate planning, you should review your estate plan and corresponding documents, such as beneficiary designation forms. In light of the changes, you may be inclined to make certain revisions, especially if your estate plan was drafted to make use of stretch IRAs.
It may make sense to convert a traditional IRA into a Roth IRA as, generally speaking, RMDs from inherited Roth IRAs will be 100% tax-free; a distinct advantage over traditional IRAs. You will need to weigh the current tax liability for a conversion against the benefit of future tax-free payouts in order to make the best decision for your particular situation.
Alternatively, establishing a Charitable Remainder Trust (CRT) can be an excellent strategy. With this approach, a charity that you designate as the beneficiary of the CRT receives the trust remainder on your death, while designated income beneficiaries, such as your children, receive annual distributions from the CRT.
Similarly, you might arrange qualified charitable distributions (QCDs) to go directly from an IRA to a charity. If you're over age 70½, you don't owe any tax on transfers up to $100,000 a year (but contributions aren't deductible either). Significantly, the QCDs count as RMDs.
Purchasing life insurance is another potential option if you're currently between age 59½ (when you're no longer penalized for early IRA withdrawals) and the new RMD starting age of 72. It is then possible for you to use IRA distributions to acquire cash value life insurance and name a non-spousal relative as beneficiary. Although you will owe tax on the IRA distributions used to fund the policy, your beneficiaries generally won't be taxed on the life insurance proceeds, and the life insurance proceeds are removed from your taxable estate.
For an owner of a large IRA, a trust can be established for family members and a life insurance policy can be purchased inside the trust. IRA distributions can be utilized to make gifts to the trust to pay the life insurance premiums. At death, the death benefit funds a trust that provides a regular income stream to beneficiaries.
Take steps to give yourself, and your family, Peace of Mind today by ensuring that your Retirement Planning is up-to-date with the passing of the SECURE Act. Contact Clinch Law Firm, LLC to schedule a free consultation at our York, Nebraska office, or feel free to schedule a complimentary 30-minute telephone consultation or a 60-minute in-person consultation for a time that works for you here: Appointment Scheduler. Virtual appointments are also available, upon request.