By David Szeremet and Terry L. Garrard Jr.
The SECURE Act is great news for holistic advisors. While the dust continues to settle on the act, advisors with well-rounded practices are quickly realizing that the act touches nearly all aspects of their clients’ financial lives.
The act creates opportunities for retirement accumulation planning, retirement distribution planning, tax management, charitable giving and estate planning.
Retirement accumulation planning. The act created a retirement saver’s mulligan. Individuals can now contribute to an IRA beyond age 70 ½, assuming they have wages or earnings from self-employment. There is no maximum age. It’s a statutory nod to increased longevity and the realization that most Americans do not save enough for retirement. Astute advisors are getting in front of this story.
The act also extends the required beginning age for required minimum distributions from 70 ½ to 72. It adds up to another two years of accumulation time, benefiting savers who may have been late to the party. Further, account owners may continue contributing even if they are in the RMD phase. An IRA contribution may exceed the RMD, creating additional opportunities to accumulate retirement savings on a tax-deferred basis.
Retirement distribution planning. As of 2020, the Stretch IRA for most beneficiaries is eliminated. Generally, beneficiaries may no longer spread IRA distributions over their lifetime. Instead, IRAs (Roth included), must be distributed by the end of 10th year following the account holder’s death.
There are a few exceptions to the 10-year forceout, including:
- Surviving spouses have the same options as before (spousal rollover, etc.)
- Beneficiaries who are less than 10 years younger than the IRA owner (e.g. siblings) may continue to a use a lifetime distribution method.
- Beneficiaries who are disabled or chronically ill may use a lifetime distribution method.
- Minor children (but not grandchildren) of the IRA owner may delay the 10-year period until reaching the age of majority.
During the 10-year period, there is no RMD. For example, a beneficiary could leave the entire amount in the inherited account until the end of the 10th year. The beneficiary would then take a lump sum distribution of the entire account. Alternatively, a beneficiary could spread distributions evenly over 10 years - or any combination as long as the 10-year deadline is satisfied.
The 10-year forceout is included in the revenue section of the SECURE Act. The message is clear: The forceout is intended to increase revenue for the federal government - and generate that revenue more quickly. The compressed distribution period could also push the beneficiary into a higher tax bracket creating a tax “double whammy” (compressed income taxed at a higher marginal rate).
IRA owners and beneficiaries should work closely with a tax advisor to determine the appropriate distribution pattern. In some cases, a gradual distribution pattern (to prevent bracket creep) may be advantageous, while in other cases a lump sum distribution (taxpayers with large deductions in a given year) may be appropriate.
If the IRA is intended as a legacy asset for heirs, repositioning the IRA into life insurance may be a better solution because it has the ability to create an income-tax-free, lump sum benefit. But don’t delay. In nearly all cases, it’s most cost effective to purchase life insurance now. After all, we may never be as young and as healthy as we are today.
Roth IRA conversions take center stage. There are four reasons why Roth conversions remain in the planning spotlight: 1) Roth accounts do not have RMDs for both the owner and surviving spouse; 2) Roth distributions can be timed to market performance and income needs; 3) Roth distributions provide income tax diversification in the form of a tax-free bucket that can be accessed as needed, and 4) Roth IRAs pass an income-tax-free legacy to heirs.
To provide flexibility, married couples should also consider the purchase of life insurance on the life of the IRA owner. After the IRA owner’s death, the surviving spouse may decide – but is not obligated - to convert to a Roth. The income-tax-free death benefit may cover the income taxes due at the time of conversion. If a Roth conversion is not indicated, the death benefit can be used for lifetime income needs or passed to heirs as a legacy. It’s all about flexibility.
Charitable “stretch.” For IRA owners who are charitably inclined and are jonesing for a stretch IRA, a charitable reminder trust can provide a workaround. An IRA owner names a CRT the beneficiary of an IRA. At the owner’s death, the IRA is distributed to the trust, which in turn uses the proceeds to create a lifetime income payout to a non-charitable beneficiary (for example, the donor’s daughter). The lifetime income payment mimics a stretch IRA. At the daughter’s death, the trust remainder passes to the charity. The CRT strategy is appropriate for people who are charitably inclined because the remainder amount passing to charity must be at least 10% of the value of the donated asset.
To complete the legacy, life insurance is often purchased on the life of the IRA owner to replace the value of the donated asset. To minimize taxes and provide protection from creditors, an irrevocable life insurance trust (aka wealth replacement trust) may be indicated.
Let’s consider “A tale of two trusts.”
Trust A. Jane, age 60, has a revocable living trust that she does not anticipate needing to access for retirement income. She has set aside the IRA and named her trust as the beneficiary of her IRA. The trust contains language specifically authorizing the trustee to stretch her IRA over her son’s lifetime. At Jane’s death, the trustee would take RMDs based on her son’s life expectancy and distribute them to him. The son would be responsible for income taxes (if any).This is a classic “conduit” trust.
The SECURE Act makes the stretch language obsolete. The 10-year forceout rule requires the IRA to be liquidated within 10 years, trust language notwithstanding. This could result in compressed income and potentially higher taxes for Jane’s son.
Trust B. After consulting with her attorney, Jane decides to take a new approach using an old planning technique – an irrevocable life insurance trust. Jane will gradually draw down some of her IRA by taking a series of penalty free distributions and repositioning them into the insurance trust. After-tax IRA distributions are gifted to the trust annually for the purchase of a life insurance policy insuring Jane. At her death, the lump sum, tax-free benefit will be used to mimic a stretch IRA for her son.
Generally, the earliest time to start funding this strategy is at age 59 ½ when distributions from IRAs are penalty-free. It is possible to take penalty-free distributions prior to age 59 ½ using substantially equal periodic payments under Internal Revenue Code section 72(t) but the rules are complicated and are generally not recommended.
Innovative annuity and investment product offerings on the horizon. The SECURE Act has several provisions that will expand opportunities for small businesses to implement or increase participation in retirement plans. For example, it will be easier for businesses to combine resources and save costs by using multiple employer plans. Additionally, a new safe harbor will improve access to annuity products that meet certain requirements within 401(k) plans, reducing liability concerns for the employer. And finally, some small businesses will be eligible for a tax credit of $500 to encourage automatic plan enrollment and offset some of the plan start-up costs.
There is an opportunity here to re-engage with small-business owner clients who may have in the past declined to open 401(k) plans because of concerns about cost and liability. You should expect plan providers and record keepers to package new products and services specifically tailored to meet the needs of this new and expanding marketplace.
A new planning tool - required projection. One of the least talked about, but perhaps the most impactful provisions of the SECURE Act is the lifetime income disclosure requirement. The act requires that all retirement plan participants receive an annual estimate of what their lump sum account balance would generate in income if converted to a lifetime annuity. The Department of Labor was given 12 months under the act to create a framework to make the lifetime income disclosure. However, once implemented, it’s easy to predict how plan participants will react when these income projections do not measure up to expectations.
Use the projection to show clients what they have, and conversely, what they don’t have. Most clients will be surprised (and some will be shocked) to see the projected income amount. The projection should carry credibility because it uses the client’s own data applying mandated calculations. This report may provide the motivation clients need to get serious about planning, and allow financial professionals to have productive conversations with them around increased savings rates, or setting up supplemental retirement income funds in IRAs and annuities.
Life insurance, annuities and retirement plan products, along with your sound advice, are important elements of your toolkit to address the changes under the SECURE Act. As with any piece of legislation there are certainly tradeoffs, but within the act there are clearly significant opportunities to demonstrate your value to clients and help them understand their options for ensuring a prosperous retirement.
David Szeremet, JD, CLU, ChFC, is vice president, advanced planning, at Ohio National Financial Services. He may be contacted at [email protected].
Terry L. Garrard Jr., MBA, ChFC, is Assistant Vice President, ONESCO Sales & Marketing, at The O.N. Equity Sales Company. He may be contacted at [email protected].
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