4 Estate Strategies for Affluent Retirees Under the SECURE Act

Successful estate planning takes taxes into consideration, and some significant retirement legislation that just became law changes the equation on that. Here are four specific ways to protect your heirs and yourself.

By Evan T. Beach, CFP®, AWMA®

published 30 December 2019

in Features

(Image credit: Westend61 / zerocreatives (Westend61 / zerocreatives (Photographer) - [None])

In the last decade, I have watched the federal estate exemption bounce between $650,000 and $11.4 million. The easiest way to explain the exemption is as a “coupon” that is handed in at death to “pay” for all the things you have accumulated throughout your life. As long as those things are worth less than $11.4 million (2019 limit), you don’t have to pay federal estate taxes. If you’re married, double that number.

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The Tax Policy Center estimates that nationwide only 1,900 estates were taxable in 2018, which is less than 0.1% of the number of people who died that year. With so few people worried about having that obligation, estate planning has shifted from trying to avoid the federal estate tax to how to minimize headaches, capital gains taxes and income taxes for the next generation.

The SECURE Act has added a significant speed bump when it comes to minimizing income taxes for non-spouse beneficiaries. But there are ways to smooth that bump out a bit.

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1. Consider splitting primary beneficiaries on your IRA

With a few uncommon exceptions (including the chronically ill and disabled), non-spouse IRA beneficiaries of people dying after Jan. 1, 2020, will no longer be able to stretch distributions over their life expectancy. This is being referred to as “the death of the stretch,” and it can have some big tax consequences.

In the United States, life expectancy is just shy of 80. If a 30-year-old were to inherit an IRA worth $2 million, the first-year distribution under the old rules would be $37,524. Under the new rules, the whole amount would have to be distributed within 10 years of the year following the year of death. If you split that evenly, that’s $200,000 per year. The tax ramifications of this are significant and explain the motivation of the legislation’s authors: More tax revenue for Uncle Sam.

Take the previous example and add a spouse to the IRA holder. That changes things a bit. Assuming the surviving spouse has enough resources to live without the full IRA (not an assumption to take lightly), to save on taxes the family would be better off splitting the primary beneficiary between the surviving spouse and the 30-year-old child. When the spouse inherits, she can treat the IRA as her own and transfer it to her own account. At that point, she will take distributions of the $1 million she inherited, based on her own life expectancy. The 30-year-old will start his 10-year distributions, but on $1 million, instead of $2 million. His taxable distributions at this point would be $100,000 per year.

When his mom passes, he will have a new 10-year period on the other half of the money. This could substantially increase the distribution period and therefore, reduce the tax bill.

2. Look at using charitable trusts to generate longer streams of income

A charitable remainder trust (CRT) is a nifty tool for the charitably-minded who are looking to donate big dollars but also would like to generate income while they are still alive. From a 20,000-foot view, this often involves donating appreciated investments to a trust, skipping the capital gains, getting a tax deduction and generating an income stream. At death, the remainder is given to the charities of your choice.

Historically, these trusts were most often established during life with income going to the grantor. The SECURE Act may change that.

One strategy that will likely gain traction is naming a CRT as an IRA beneficiary. In the trust, you would likely name your child as the income beneficiary of the CRT, which would allow that child to stretch the distributions out for more than 10 years. At the death of the child or at the end of the term of the trust, the money will pass to the named charities.

3. Consider making Roth IRA conversions

Life is full of tax peaks and tax valleys. The peaks are those high-income years, which, in turn, lead to high-tax years. The valleys are just the opposite. The most common valley comes between retirement and age 70½. Under the SECURE Act, that valley will be extended to age 72, as required minimum distributions (RMDs) are delayed for anyone born on July 1, 1949, or later.

Imagine that you go to the grocery store every week to buy Cheerios. They typically cost $4, but this week they are on sale for $2. Unless you are strapped for cash, you are likely to stock up and pay half the price for the same product. Tax valleys afford you the same opportunity to pay taxes on sale. Roth conversions allow you to move money from a pre-tax position to an after-tax Roth IRA and recognize that income in the lower, tax-valley year. That money will grow, tax-deferred, and qualified distributions are tax-free. There are no required minimum distributions for the owner, and the money can pass tax-free to the beneficiary.

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Roth conversions became more popular under the Tax Cuts and Jobs Act. Their benefit is amplified by the SECURE Act. They are as close to “trendy” as something can be in the financial planning world.

4. Revise or get rid of the trust

If you look approximately 4 inches north, you’ll see me advising you to name a trust as a beneficiary of an IRA. Now I am telling you to get rid of the trust as the beneficiary of your IRA. However, here I am talking about getting rid of the revocable trust as a beneficiary. It is an ongoing debate as to whether naming a revocable trust as the beneficiary of an IRA is a best practice. The trust needs a “see-through” provision and can be treated differently at death by different custodians. Unless the trust has been updated since the passage of the SECURE Act, it should likely be eliminated as the beneficiary of your IRA.

Conduit trusts, which are a subset of revocable trusts, are commonly named as IRA beneficiaries to keep spendthrifts from taking any more than the required minimum distribution. Using the initial example, where the 30-year-old inherits a $2 million IRA, there actually is no RMD until year 10, at which point, the RMD would be the entire amount of $2 million. All of that money would be taxable as income in that year, and you would likely lose almost half of it to taxes. That’s the sort of generosity the IRS loves.

All of the above strategies are complex and should be worked through with your estate, tax and financial advisers. This will create a busy year for our firm as we rework the strategies we have in place to efficiently transfer assets to the next generation. If nothing else, use the SECURE Act as the reason to dust off that estate plan that was drafted when your first kid was born.

Observations from the Brink of Retirement

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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After graduating from the University of Delaware and Georgetown University, I pursued a career in financial planning. At age 26, I earned my CERTIFIED FINANCIAL PLANNER™ certification. I also hold the IRS Enrolled Agent license, which allows for a unique approach to planning that can be beneficial to retirees and those selling their businesses, who are eager to minimize lifetime taxes and maximize income.