SECURE Act Strategies

A couple of weeks ago, I discussed the SECURE Act, a recent law change affecting retirement accounts.

Today, I want to zero in on one particular aspect of the SECURE Act that will affect anyone with an IRA, 401(k), 403(b) or other retirement accounts who leaves money to a non-spouse beneficiary at his or her passing.

That’s nearly everyone.

Prior to the passage of the SECURE Act, an heir who inherited an IRA had the option of doing a ‘stretch out’ IRA.  In essence, a stretch out allowed that heir, typically a child of the deceased IRA owner, to keep the money in an ‘inherited IRA’ and take required minimum distributions based on the heir’s remaining life expectancy.

Say a 50-year old inherits an IRA from his mother who recently passed on.  Per the IRS single life expectancy table, that son who has a life expectancy of 34.2 years could take a distribution equal to the inherited IRA account value divided by 34.2.  If the inherited IRA had an account balance of $500,000, the distribution required the year after his mom’s passing would be $14,620.  Taxes would be paid on that distribution amount and the balance of the inherited account would continue to grow on a tax-deferred basis.  The next year the distribution factor would be adjusted by one year.  It would be reduced from 34.2 to 33.2.

Using this stretch out strategy, it was possible for one who inherited an IRA to adopt the inherited IRA and use it as his or her own retirement account.

No more.

Under the new law, any inherited IRA must have the taxes paid on the inherited balance within 10 years.  That totally kills the stretch out strategy that so many had incorporated into their planning.

But there may be a viable alternative for those who wish to use a stretch out type approach in their planning.

This approach is probably best explained through an example.

A 60-year old single woman with three daughters has an IRA with a current balance of $1,000,000.  She wants to use her retirement account to provide income for her daughters when she passes.  Her daughters are presently 35, 32 and 30 years old.

She establishes three charitable remainder trusts.  Each of these trusts has one of her daughters as the income beneficiary.

A charitable remainder trust is an irrevocable trust that has income paid to an income beneficiary for the life of the income beneficiary and then, at the death of the income beneficiary, the remaining trust balance passes to a selected charity or charities.

The level of income that an IRA owner can draw from the charitable remainder trust must be at least 5% of the trust balance and could be higher provided certain minimum IRS rules are met.

Again, an example, let’s say that by the time each of the three daughters inherits their Mom’s IRA, each of the three daughters inherit $500,000.  The $500,000 balance is paid into the charitable remainder trust and no tax is paid.

Now, each daughter may be able to collect an annual income of $25,000 as long as she lives.  At each daughter’s passing the remaining trust balance passes to a charity.

Each daughter will pay taxes on the income received each year; however, this strategy can allow the IRA owner to establish a stretch-life vehicle to use as part of an estate plan.

Another nuance to this strategy that can be incorporated is the use of a relatively low-cost life insurance policy to provide an additional tax-free benefit to each daughter. 

The life insurance policy type that would work well in this design is a no-lapse guarantee policy.  This kind of policy guarantees that the policy won’t lapse before a certain age as long as the premiums are paid on a timely basis.  Think about this kind of policy as a term life until you die policy.

It does not build cash values.  It provides only protection.

In the case of this 60-year old woman, a $1,000,000 non-lapse guarantee to age 100 policy could be purchased for a level premium of $1,045.20 per month as long as the proposed insured was in good health.

When one considers the outlay versus return on a policy like this one, it can be very favorable.

A premium outlay of $1,045.20 monthly equates to about $12,543 per year.

Assuming this 60-year old passes on at age 90, she will have paid about $376,000 in premiums in exchange for a guaranteed death benefit of $1,000,000 that could be paid to her daughters’ income tax-free.

The premiums for this no-lapse guarantee policy can be paid from the IRA.

At her passing at her assumed age of 90, the three daughters will each receive $333,333 in tax-free cash and another $25,000 per year for as long as they live.

Taxes will be minimized and a charity that might not otherwise benefit gets named as the remainder beneficiary and will ultimately receive everything left in the trust.

Arguably, depending on one’s charitable intent, this can be an even better outcome than using a stretch-out strategy.

If you’d like to explore plan designs for this strategy, give the office a call at 1-866-921-3613.  We’d be glad to put a report in writing for you to review.