In January, my blog post on the SECURE Act touched on a variety of changes to tax-deferred accounts. Considering the weighty topic being discussed, I am going to extend the series into a 3rd part later. In today’s follow-up, I want to focus on a few options to revise your IRA planning considering the changes.
Flexible Options for Dealing with the Loss of the Stretch IRA
Revisiting the example from my last post:
A widower, with the bulk of his wealth in a rollover IRA, passes away on January 1, 2020 and leaves the $1,500,000 account to his 35-year-old daughter, who is married and averages $75,000 adjusted gross income annually.
For our purposes, we make the following assumptions:
- The marginal tax owed from the IRA distributions will be paid from the IRA distribution proceeds.
- Distributions are taken at year-end and proceeds net-of-tax are reinvested.
- Current tax rates will remain in place for the next 10 years.
Regardless of the rate of return, taking annual distributions on a sliding scale (1/10 in year 1, 1/9 in year 2, and so on until the full balance is liquidated in year 10) is more tax efficient than taking the full balance out in year 1, or keeping it fully invested for 10 years and paying the tax on the back end. This should be self-evident as the lump sums move our example into the highest marginal tax bracket, and not by a small amount. Of course, one could strategically take distributions annually to bump themselves up against the next tax bracket, but that is a complicated example better implemented by a professional wealth planner.
Under the previous stretch IRA provisions and an annual 6% rate of return, the heir would have amassed an inheritance over 30% higher by the end of the 10 years, with the majority of it remaining in a tax-deferred vehicle rather than in an after-tax account. Famed estate planning lawyer Natalie Choate has accurately described this result as “the best middle-class tax shelter has been turned into a worst middle-class tax trap.”
One way an IRA benefactor can help plan around this provision is to consider any income inequality between heirs. In this well-written piece titled “A Tax-Smart Beneficiary Plan for The SECURE Act”, author James Blase proposes leaving IRA assets to children in lower income tax brackets. The higher-earning descendant can inherit non-IRA assets that may continue to grow rather than being forced to liquidate and pay taxes at their already high income tax rate while planning provisions can leave the lower-earning heir cash to offset the tax due.
Finally, those who are charitably inclined could consider naming a Charitable Remainder Trust (CRT) as the beneficiary assuming the charitable inclination exists and the lifetime beneficiary is not dependent on the inheritance. A CRT names a lifetime beneficiary who receives annual distributions taxed as ordinary income, with the assets going to a charitable beneficiary when the lifetime beneficiary passes away. This strategy effectively reinstates the stretch provision.
As always, any of these solutions should be reviewed with the appropriate advisor on your financial team.
The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts or Lincoln Investment. The material presented is provided for informational purposes only. You should discuss any legal, tax or financial matters with the appropriate professional.