After establishing an estate plan, it is essential to regularly review it in its entirety to ensure that your client’s will or trust still aligns with their long-term goals and expectations. While this can be done on an annual or quarterly basis, it is also important to return to their plan after a major life event—or a change in government regulations.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act was initially passed at the end of 2019, with many of the new rules immediately going into effect on Jan. 1, 2020. However, starting this year, a new mandate takes effect, and how the IRS is interpreting it may impact you and their beneficiaries moving forward.
If you created an estate plan prior to the creation of the SECURE Act, read on to learn how it may alter your strategy as well as which tax-efficient option may be available to you.
An Overview of the SECURE Act
The SECURE Act was first signed into law in 2019. When the act was initially created, its goal was to expand retirement options for employees while also simplifying the process of offering employer-sponsored plans for businesses.
In an effort to help Americans better prepare for retirement, the new regulations introduced several positive changes, including broadened eligibility for 401(K) plan participation while also offering small-business owners a tax credit for starting workplace retirement plans, as reported by Kiplinger. However, in addition to these benefits, the SECURE Act also created new complexities for anyone who had already established an estate plan. For many investors, this has led to uncertainty as to whether their existing strategies would still work for them and their loved ones.
How Inherited IRAs Will Change
Before the start of 2020, the beneficiary of an inherited individual retirement account (IRA) was able to defer taxation over their lifetime by taking required minimum distributions based upon the age of the beneficiary. This essentially created a “stretch IRA” in which the beneficiary could keep the money in place for years, allowing it to grow continuously. Although the account inheritor still had to pay income tax on withdrawals, they were able to spread the distribution for
decades. Now, that timeline has been significantly reduced.
As Yahoo Finance explained, the SECURE Act has officially put an end to stretch IRAs. As of 2022, all of the money in an inherited IRA must be taken within 10 years after the person who created the account passes. This could be taken out all at once as a lump sum—for example, one option is to remove the funds and invest somewhere required minimum distributions
(RMDs) do not apply. Over that 10-year period, the money can be taken out at a rate of 10% annually, or in any other combination of withdrawals.
However, the end of stretch IRAs is not the only concern the SECURE Act has created. Now, if an account owner passes after turning 72 and had already begun taking RMDs, the beneficiary is required to take out a yearly withdrawal in addition to removing all of the money at the end of the 10th year.
For those with an established estate plan, this means they cannot push back the tax bill for a full 10 years for their children or grandchildren if they live past 72. The only exceptions to this rule are cases in which the beneficiary is a surviving spouse, a child under the age of 18, or a disabled or chronically ill beneficiary who is up to 10 years younger than the deceased
retirement account owner.
A Potential Alternative
As a result of the SECURE Act, an account beneficiary will now have to determine the best strategy for withdrawal, based upon their own income and tax bracket. Additionally, they will need to take out larger amounts of money at once—while also being taxed on that larger distribution.
One strategy to navigate the impact of the SECURE Act is to instead use a Roth IRA. As Kiplinger explained, Roth conversions transfer the tax liability to the account owner, which essentially means they will owe on any taxes converting, “prepaying” the bill for their heirs. This can be a tax-efficient way to reduce the strain on their beneficiary, especially if the conversion
occurs early in retirement.
In addition to the benefit of tax-free withdrawals, a Roth IRA has an added bonus for heirs: They can leave the funds in the account to grow tax-free for 10 years. Because of that, their inheritance could be even more substantial than originally anticipated.
It is important to note that estate plans are not a one-size-fits-all strategy and long-term goals both during retirement and after one passes should be considered. Although a Roth conversion is often the most tax-efficient option, some investors may want to look toward other solutions, such as prepaying their tax bill using a life insurance policy.
Evaluate and Adjusting Estate Plans
Continuously reviewing and updating your clients’ estate plans over time has always been a best practice. However, it is more essential than ever before to evaluate each existing strategy and ensure it still achieves each client and their family’s desired financial outcomes, while remaining in compliance with the SECURE Act.
