By April Reed Crews
One of the most impactful pieces of financial legislation in more than a decade was signed into law by President Donald Trump at the end of 2019. Financial advisers and investors alike began 2020 with a list of questions on the Setting Every Community Up for Retirement Enhancement Act, or the SECURE Act, attempting to discern the advantages and disadvantages of the legislation and what actions may be required both to protect investors and to maximize opportunities presented by the act.
Advanced beneficiary planning conducted by the owners of large retirement accounts may very well now be in jeopardy. It is estimated that the SECURE Act will generate nearly $16 billion in additional tax revenue over the next decade, but there are strategies that can be implemented now to help reduce the tax burden that will be felt by both retirement account owners and their beneficiaries.
Perhaps the most widespread concern stems from the elimination of the Stretch IRA -- a change that could significantly impact the beneficiaries of retirement accounts. Under previous law, beneficiaries were mandated to take required minimum distributions (RMDs) annually, but were able to stretch out distributions over their life expectancy. Under new regulations, most beneficiaries will now have to empty accounts -- and pay taxes -- over 10 years.
Additionally, conduit trusts that were established to disseminate required minimum distributions to beneficiaries over time are now an exposure for the very beneficiaries that they were designed to protect.
A paradox was created with the elimination of RMDs for beneficiaries and the transition to a 10-year payout. If a conduit trust specifies that RMDs should be paid to beneficiaries, this means that beneficiaries will receive no distributions at all from RMDs since they are no longer applicable; instead, beneficiaries will have nine years without any distributions and a taxable lump-sum payout in the 10th year.
Nathan Powell, head of the wills, trusts and estates practice at Powell & Edwards, emphasized that these trusts should immediately be examined by a qualified estate planning attorney to adjust the verbiage regarding distributions, as the conduit trust becomes irrevocable upon death.
"The SECURE Act largely eliminates the benefits of see-through, or conduit, trusts," said Powell. "Without careful, comprehensive planning to realign goals within the act's paradigm, there is a significant risk that a large percentage of our clients' net worth could be taxed at the maximum income tax rate."
For those who wish to provide tax-advantaged income to beneficiaries and who are also charitably inclined, there are alternative strategies to consider. One such strategy is to name a charitable remainder trust as a beneficiary on qualified accounts, specifying a period of time for beneficiaries to receive income and then donating the remainder to a specified charity.
Another approach is naming a charity as an IRA beneficiary. While the charity receives the proceeds of the IRA income-tax free, the original intended beneficiaries could instead be named as beneficiaries of life insurance, paying no income taxes on the proceeds.
Reducing Tax Burdens Stemming From the SECURE Act
Qualified accounts such as IRAs, 401(k)s, and 403(b)s are tax-deferred, meaning that all distributions are fully taxable. Account owners can only defer the distributions until the RMD date, at which time the IRS mandates a specific annual amount that must be distributed in the form of a taxable distribution.
Within the SECURE Act is an adjustment of the age at which required distributions must begin from qualified retirement accounts, increasing the distribution date from the year of attaining age 70½ to 72. While this does not pertain to those who turned 70½ in 2019, anyone who turns 70½ in 2020 or beyond will not have to begin disbursements until the year that they turn 72. This extends the time frame for Roth IRA conversions that can be optimal for those who are striving to reduce their overall income tax burden both for their retirement and for their heirs.
Between the ages of retirement and the required beginning date, a series of strategic Roth IRA conversions over multiple tax years can help investors slowly reduce their overall positions in qualified retirement accounts while staying in a lower income tax bracket. At the time of conversion taxes must be paid, but Roth IRA account owners do not have to take RMDs from their Roths, and if they hold the funds in the Roth for at least five years, then no taxes are due upon distribution of the Roth funds.
This strategy can be particularly advantageous for retirees who have sufficient non-retirement investments and savings to cover their expenses during the early years of retirement. A retiree who is 62, and is able to delay taking distributions from their qualified retirement accounts until the mandated age of 72, may have as long as a decade to convert funds to a Roth IRA each of those years. If a married couple is able to defer Social Security and distributions from qualified accounts until required distribution dates, hundreds of thousands of dollars could possibly be converted over a decade or less while staying in a 12% marginal tax rate.
The IRS previously allowed recharacterizations of Roth conversions, allowing a window of opportunity to "undo" the conversion. The Tax Cut and Jobs Act repealed the ability to recharacterize from 2018 forward, making it even more crucial to work with a qualified CPA to adequately assess Roth conversions.
The Roth conversion approach can also lend an advantage to beneficiaries. Although both Traditional IRAs and Roth IRAs now have to be distributed within 10 years for most beneficiaries, the distributions are not taxable from Roth IRAs.
Old Strategy, New Trick?
The elimination of the Stretch IRA leaves owners of large qualified accounts with a conundrum about how to avoid passing tax burdens to their heirs, but the Roth conversion strategy may not be the only arrow they should have in their quiver.
Qualified charitable distributions (QCDs) are a provision in the tax code that allow required minimum distributions to be directed to qualified charities. This method allows the RMD to be satisfied, avoiding the 50% penalty for failing to distribute, without the account owner taking receipt of the funds or paying any taxes on the distribution. For those who are charitably inclined and may be making charitable donations from other sources, this shift in strategy could help reduce overall taxes. An individual can direct as much as $100,000 ($200,000 per married couple) of qualified charitable distributions annually.
Defining 'Most Beneficiaries'
The elimination of the Stretch IRA does not pertain to all beneficiaries. Rather, there are provisions making beneficiaries, called eligible designated beneficiaries (EDBs), exempt from the new 10-year payout schedule. These EDBs include:
- Surviving spouses
- Minor children, up to majority -- but not grandchildren
- Disabled individuals -- under IRS rules
- Chronically ill individuals
- Individuals not more than 10 years younger than the IRA owner (generally, siblings about the same age)
Some of these EDBs aren't as straightforward as they may seem. For example, if an account owner dies and leaves their minor child as a beneficiary, they can only stretch distributions under the old rules until they reach the age of majority. Once they attain the age of majority, they must then distribute remaining assets from the qualified plan over the following 10 years. The age of majority, which is determined at the state level, is typically age 18.
The SECURE Act includes a myriad of additional adjustments that will impact more than retirees and those near the age of retirement. Some of these key changes include:
- Elimination of the maximum age restriction for IRA contributions (previously age 70½)
- Enhancements to costs that can be covered by 529 plans, including distributions for qualified student loan payments (available for both the 529 plan beneficiary and their siblings)
- Enhanced retirement account liquidity for home purchases and education
- Ability for companies in non-related industries to jointly form 401(k) plans for multiple employers
About the author: April Reed Crews is the CEO of Reed Financial Group, a family owned and operated company who has served families and retirees throughout Georgia since 1979. April is an investment advisor representative, making her a fiduciary by law to her clients. She specializes in retirement and income planning, and has distinguished herself as an Ed Slott Elite IRA adviser since 2010. Investment advisory services offered through Brookstone Capital Management, LLC (BCM), a registered investment adviser. BCM and Reed Financial Group are independent of each other. Insurance products and services are not offered through BCM but are offered and sold through individually licensed and appointed agents. Third-party ratings and recognitions are no guarantee of future investment success and do not ensure that a client or prospective client will experience a higher level of performance or results. These ratings should not be construed as an endorsement of the adviser by any client nor are they representative of any one client's evaluation.