Estate Planning for IRAs After the Secure Act

Estate plans for taxpayers with substantial individual retirement accounts (IRAs) were upended by the Setting Every Community Up for Retirement Enhancement (SECURE) Act, enacted in December 2019. The key provision of the SECURE Act ended the Stretch IRA. In a Stretch IRA, the beneficiary maximized the IRA’s tax deferred com-pounding of income and gains by taking only required minimum distributions (RMDs).

The IRA could last, or would stretch, for decades and compound to a much higher amount before being used to fund major life expenses, including the beneficiary’s own retirement.After the SECURE Act, most inherited IRAs must be distributed fully within 10 years. The beneficiary can wait until the end of the 10th year to distribute the full account or can take distributions in any pattern over the 10 years.

But it must be distributed by the end of 10 years.The 10-year rule applies to both traditional IRAs and Roth IRAs.Exceptions to the 10-year rule are IRAs inherited by a surviving spouse, a disabled person, a chronically ill person, a minor child, or someone less than 10 years younger than the original IRA owner.

When a minor child inherits an IRA, the 10-year clock starts running after he or she reaches the age of majority in his or her state of residence. Note that grandchildren don’t qualify for an exception to the 10-year rule. The SECURE Act rules apply to the IRA beneficiaries of anyone who passes away after 2019.

After 2019, an IRA beneficiary usually ends up with less after-tax wealth than a beneficiary before 2020, unless a new strategy is implemented.Fortunately, there are strategies that can deliver your beneficiaries after-tax wealth similar to or better than the Stretch IRA. These strategies often have additional benefits, such as protection from creditors and wasteful spending plus guaranteed income or balances.

These strategies are for retirement account owners whose primary goal is to leave their IRA balances for children or other loved ones and prefer the beneficiaries don’t spend the wealth shortly after inheriting it.The easiest strategy is to convert a traditional IRA to a Roth IRA.

I’ve discussed many times how to determine when an IRA conversion is beneficial. After the SECURE Act, a beneficiary is more likely to have greater after-tax wealth when an IRA is convert-ed than when it isn’t.

A conversion really pays off when the beneficiary will be in a higher tax bracket in the future but also makes a lot of sense when there’s no change in rates.A conversion also is more advantageous when you plan to name a trust as the IRA beneficiary. Since Roth IRA distributions are tax free, the trust isn’t taxed at a high rate the way it would be if it received distributions from a traditional IRA.

You can find more details about the issues to consider before converting an IRA in our February 2019 issue. Also, take a look at my book, “The New Rules of Retirement-Revised Edition” and this month’s IRA Watch.Another strategy to replace the Stretch IRA is the charitable remainder trust (CRT).

A CRT is very flexible, but in a typical arrangement you draft a charitable trust agreement as part of your will and name the trust as beneficiary of your IRA.The IRA is distributed to the trust soon after you pass. The trust pays lifetime income to your children or other beneficiaries, beginning either right away or at a time in the future. After the children pass away, the remaining trust assets are paid to one or more charities you named, or you can allow the CRT beneficiaries to name the charities.

The CRT provides beneficiaries with financial results very similar to, and frequently better than, those of the Stretch IRA. Have your estate planner run projections showing results in different scenarios.The trustee invests the CRT assets, so there’s no risk unsophisticated heirs will invest poorly. The trust agreement deter-mines the amount of the distributions, which prevents the beneficiaries from spending the money rapidly. The CRT also protects the assets from creditors of the beneficiaries to the extent the assets haven’t been distributed.

Many large charities will manage a CRT for little or no fee when they are ultimate beneficiaries of at least a portion of it.A related strategy is the charitable gift annuity (CGA). You can designate that after you pass away your IRA will arrange to transfer assets to a charity in exchange for a CGA. Under the CGA, the charity will pay income to your beneficiaries for either a period of years or life.

The payments will be less than those available from a commercial annuity. The difference is a gift to the charity.The income payments can be deferred, so that income to the beneficiaries doesn’t begin until they reach a certain age. The amount of the distributions also can be graduated over the years instead of fixed. Both the CGA and CRT make only scheduled distributions to the beneficiaries. If the beneficiaries need additional cash at times, they must seek it from other sources.

Other strategies for repositioning your IRA, which often have powerful results, involve using IRA distributions to purchase permanent life insurance. Repositioning your IRA as life insurance has several benefits. The life insurance payout received by your beneficiaries is income-tax free, unlike inheriting a traditional IRA.

The amount your loved ones will inherit with life insurance doesn’t fluctuate with the markets. It is guaranteed, and with some types of life insurance might increase over time. You and your family might have lifetime tax-free access to part of the policy’s value through loans. The loans don’t have to be repaid but will reduce the final life insurance benefit and might be interest free.

These are flexible strategies that can be adjusted to your circumstances and goals.Here’s one example of how to reposition your IRA using life insurance.Suppose you are 64, in good health and have a $500,000 traditional IRA.You roll over the IRA to an account with the insurer. Each of the first five years you take a distribution from the account, pay income taxes on it and transfer the $105,732 after-tax amount to pay the premiums on a Max-Funded Indexed Universal Life policy.

The policy has a benefit of $1,182,368 payable to your beneficiaries.After the first year, you can arrange an annual loan secured by the cash value of the policy that is used to pay the taxes on the amounts transferred from the account to pay the premiums. After five years, the policy is paid up and the account is empty.

You won’t have to take RMDs in the future. You converted the IRA into life insurance without using any of your other resources. Loans used to pay the taxes eventually are subtracted from the policy benefit. You also might be able to add a long-term care benefit for you to the policy.

You’ve turned a $500,000 traditional IRA into a life insurance benefit of more than $1 million. In addition, the policy will have a cash value account that can be tapped tax free during your lifetime.

The cash value would be more than $300,000 after 10 years and $600,000 after 20 years. The details depend on your age, health and current interest rates. You can have the benefit paid directly to your beneficiaries or to a trust, which controls how the money is distributed to them.

Here’s another IRA repositioning strategy using insurance.Suppose you are married, both 71 and in good health. You have a $1 million IRA plus other income and assets to fund your retirement. You plan to leave most of the IRA to your children and grandchildren.

You don’t need the RMDs you’ll have to take from the IRA and are concerned the children and grandchildren will spend the IRA too rapidly after inheriting it.You can set up a family dynasty trust that benefits your grandchildren, your children or both. The trust buys a permanent life insurance policy of which the trust is beneficiary.

You make a gift to the trust each year equal to the after-tax amount of the RMDs, which should avoid gift taxes because of the annual gift tax exclusion ($15,000 in 2020 and 2021) and the lifetime estate and gift tax exemption. If the trust buys a joint and survivor life insurance policy covering both you and your spouse (usually the way to maximize the life insurance benefit), the policy will have a benefit of almost $1.4 million.A

fter you and your spouse both pass away, the life insurance benefit is paid tax free to the trust. The trust invests and distributes the money according to the terms you set in the trust agreement.

It can be paid out to the grandchildren over the years, used to pay for specific needs, held until they reach certain ages, or whatever other distribution plan you want.Instead of inheriting the after-tax value of a $1 million IRA, your heirs benefit from a trust that receives almost $1.4 million tax free. There are other ways an IRA can be converted into a tax-free life insurance benefit.

These are just two examples. Life insurance strategies are very flexible. They have leverage, which often increases the benefits above the after-tax value of an inherited IRA. I learned about these and other insurance strategies from David Phillips of Phillips Financial Services.

You can learn more details by ordering David’s free report, The Bombshell Battle Plan: How to Defend Against the IRS’ Secret Weapon and the related report, Gift for Life. The reports are available free by calling 888-892-1102. Many more details about all these strategies are presented in the July 2020 episode of my Retirement Watch Spotlight Series. To subscribe, check out the Retirement Watch web site or call 800-552-1152.