Q. I completed my estate planning with your firm five years ago and elected to have my retirement plans pass into a “conduit trust” or “pass-through trust” for the benefit of my daughter, Hannah. My understanding was that the conduit trust would pay out required minimum distributions to her, and that the money would grow tax-deferred over the course of her lifetime and be passed on to her own beneficiaries. I was told this was called the “stretch IRA” option.
Now, I read about a new SECURE law that eliminates “stretch IRAs.” What is the best thing we can do now given the new law, and do we need to update our trust or other documents?
A. On Dec. 20, President Trump signed into law the Setting Every Community Up for Retirement Enhancement Act (SECURE Act). The new law was partly intended to expand opportunities for individuals to increase their retirement savings. But it also includes what many people see as significant negative changes, mainly eliminating the “stretch IRA” option for persons who inherit an IRA or other qualified plan. This enormous change in the law should prompt clients who have done estate planning to take action and possibly make updates, as I will describe.
Removal of Inherited “Stretch” Provisions
In passing the SECURE Act, several big changes occurred as we discussed in our recent article on the topic. Today, we’ll discuss the issue you raised about “stretch IRAs” in more detail. As you mentioned, the SECURE Act contains a provision that eliminates “stretch” IRAs, and it can be described as the single biggest tax revenue generator in the entire Act. Most beneficiaries will now see higher taxes and a shorter distribution period for inherited retirement accounts under this change.
Under the new law, required minimum distributions (RMDs) are not required. However, the IRA must be completely withdrawn by the end of the 10th year after the owner’s death, and if it’s held by a conduit trust, it must be completely distributed to the trust beneficiaries. In many cases, these withdrawals would occur during the beneficiary’s highest tax years, meaning that the elimination of the stretch IRA is effectively a tax increase on many Americans. This provision will apply to those who inherit IRAs starting on January 1, 2020.
A spouse who inherits an IRA is still able to treat the IRA as his/her own by rolling it over into an IRA in the name of the surviving spouse (and taking distributions over his/her lifetime). The following non-spouse beneficiaries are also given special treatment:
- Disabled or chronically ill individuals
- Individuals who are not more than 10 years younger than the account owner
- Minor children: However, once the child reaches the age of majority, he or she has 10 years to withdraw the money from the account.
Due to these changes, those with significant sums in retirement accounts need to immediately reevaluate their estate plans.
What You Should Do
Here are some actions you should consider taking to protect your beneficiaries from the ramifications of the SECURE Act:
1. Review Your Beneficiaries
Because the SECURE Act changes the outcome for many inherited retirement accounts to be distributed in a shorter time period, now is the time to review your beneficiary designation. Beneficiary designations on IRAs and 401(k)s determine who the accounts will pass to once the owner dies. Take the time to make sure all your beneficiary designations are in order and that they still match up with your intended goals. Changing a beneficiary designation might make sense to better align with your goals after the SECURE Act’s passing.
2. Consider Naming Your Spouse as Your Primary Beneficiary
Naming a spouse as the primary beneficiary of your IRAs instead of naming your children (as is quite common when you have children from a prior marriage), will allow them to continue tax-favored growth without having to follow the 10-year timeline for withdrawals. Although they are still subject to RMDs from that account based on their life expectancy, those withdrawals will likely be less than what would be required under a 10-year withdrawal plan, and your spouse is likely to be in a lower tax bracket then your children. If your children are from a prior marriage, but you were intending to leave some assets to your current spouse and some to your children, consider naming your spouse as the beneficiary of your IRA or other qualified account, and leaving other assets to your children.
3. Take a Closer Look at Your Trust
If you were using a trust as a beneficiary of an IRA or 401(k) in order to achieve creditor protections and take advantage of the stretch IRA provisions through a conduit trust, there could be a huge issue with your plan now that the SECURE Act has been enacted. Be sure to review your trust documents and beneficiary designations and have your attorney make whatever changes you both agree are necessary.
4. Perform a Tax Review
The SECURE Act should put everyone on notice that the government is looking to raise tax revenue in new ways, so it would be wise to do a tax review of your estate plan and retirement plan. In some cases, it might make sense to leave your IRA to a charity and purchase life insurance for your children or a charitable remainder trust to maximize legacy benefits.
5. Consider Doing Roth Conversions
Now might be a good time to consider a Roth conversion. Under the SECURE Act, a Roth IRA must still be distributed within 10 years. However, since the distributions from a Roth account are tax free, your beneficiaries can let the Roth account grow and then take the entire distribution at the end of year 10 with no tax consequences. Now that the income schedule has accelerated for beneficiaries, it may be even more advantageous to pass along Roth assets as opposed to traditional assets.
Thinking about whether to convert your traditional IRA assets to a Roth? Be sure to consider your current tax bracket as well as your beneficiary’s. If you think your beneficiary will be in a higher tax bracket than you are now, then it may make sense to convert your traditional IRA to a Roth now and pay the tax at your lower rate as opposed to your children taking distributions after your death at their higher tax rate. Of course, it is important to factor in the impact that paying a large tax bill today can have on your own retirement. The last thing you want is for your estate planning efforts to put your own retirement plans in jeopardy.
6. Check your Special Needs Trust
Under the new law, disabled beneficiaries fall under an exception that permits them to continue to stretch withdrawals under the previous inherited IRA age-based schedule. However, the trust will only qualify for this treatment if the disabled individual is the only beneficiary of the trust during his or her lifetime. If the trust also permits distributions to a spouse or children, it won’t qualify and the IRA will have to be completely withdrawn under the 10-year rule.
7. Consider Disclaiming
Beneficiaries of large IRAs have the option of disclaiming them and allowing their beneficiaries to stretch their withdrawals. The disclaimer has to be done within nine months of the IRA owner’s death. Disclaimed property is treated as if the person inheriting it had actually died before the decedent. The window for this option will continue to narrow until it closes completely on October 1, 2020.
8. Use Inherited Tax-free Funds to Purchase Hybrid Long-Term Care Insurance
Many people will now be inheriting traditional IRAs subject to the new “10-year-payout” rule, resulting in a perfect opportunity to plan for and fund long-term care. OneAmerica® Care Solutions has a vehicle for this by utilizing the Asset Care® Annuity which funds a whole life policy. The strategy here involves a trustee-to-trustee transfer of the inherited IRA into the Care Solutions IRA annuity with an income rider. The income rider provides ten or twenty years of required distributions from the IRA which are then used to fund the built-in whole life insurance policy. The life insurance policy will accelerate the death benefit for qualifying long-term care expenses if ever needed. There are riders available for inflation protection and even for a lifetime long-term care coverage if desired. Distributions from the IRA annuity are taxable but not subject to the 10% additional premature withdrawal tax due to the inherited status, regardless of the age of the beneficiary. This is just one product example, other alternatives exist using a variety of creative insurance policies to help leverage tax-free dollars to pay for long-term care coverage.
9. Fund your Living Trust Plus® or Possibly a Life Insurance Policy Owned by your Living Trust Plus®
There is even more reason now for individuals wanting asset protection to cash out their IRA funds (perhaps over several years to lessen the taxes, using tax bracket management for the settlor) to fund a Living Trust Plus® Asset Protection Trust, or possibly to fund a life insurance policy owned by a Living Trust Plus. This would allow the settlor to protect assets from probate, PLUS lawsuits, PLUS Veterans Benefits (after 3 years) for qualified wartime veterans, PLUS Medicaid (after 5 years). This would also allow the trustee to use the amount in the LTP (perhaps amplified due to a death benefit of life insurance purchased inside the LTP) for distributions to generate regular flexible payments to the beneficiaries – similar to a stretch IRA – after the death of the owner, as well as to achieve tax bracket management for the beneficiary.
10. Consider a Charitable Remainder Trust
If you have a significant IRA, and your goal is to give lifetime income to a child, and you desire to leave a gift to charity upon your death, you might want to consider establishing a charitable remainder trust (CRT) that will be named as the beneficiary of your IRA funds, and these funds can then be used to provide your child with lifetime income (similar to a stretch IRA) while also leaving a lump sum amount to the your favorite charity upon your child’s death. The CRT isn’t taxed on either the distribution from the IRA or income and gains it earns, but your child likely will owe taxes on distributions from the CRT (just as your child would owe taxes on distributions from a stretch IRA).
Now is the Time to Make Revisions to Your Estate Planning Documents
The SECURE Act may have a significant impact on some estate and retirement plans. Current clients who are members of our Lifetime Protection Plan® and others who have IRAs need to immediately reevaluate their estate plans, including all beneficiary designations.
Have You Planned for your Future and for your Loved Ones?
With these and other changes in the law, the need to plan in advance and to make necessary updates is more important now than ever. If you have not done your Estate Planning or Retirement Planning or had your Planning documents and Retirement Plan reviewed this year, please call us as soon as possible for an initial consultation, or a free annual review for members of our Lifetime Protection Plan®:
Estate Planning Fairfax: 703-691-1888
Estate Planning Fredericksburg: 540-479-1435
Estate Planning Rockville: 301-519-8041
Estate Planning DC: 202-587-2797
About Evan H Farr, CELA, CAP
