There are three alternatives you can use!
The SECURE Act has changed the game. I discussed the things you need to know in a previous post; but maybe the biggest game-changer, especially for parents who were planning on leaving substantial nest-eggs to their kids, is the elimination of Stretch IRAs. The big unexpected inheritor just might be Uncle Sam.
Before the SECURE Act, the child could take required minimum distributions (RMDs) based on his/her own life expectancy. Theoretically, if they inherited early, the RMD would be so small they could actually continue growing the nest egg in perpetuity – even grandchildren could benefit! No more. Now, the inherited IRA has to be liquidated in ten years.
The odds are most boomers will die when their children are in their peak earning years. So, an inherited $500,000 IRA can create some tax problems! An inheriting child in their 50s, who before the SECURE Act may have taken RMDs in the neighborhood of $17,000, will now be required to take a first RMD of $50,000…. and that’s in addition to their income during their peak earning years. Add to that the double-whammy that the current tax law sunsets in 2026 and the old 2017 tax brackets come back into effect, and you have a perfect storm – I won’t depress you with the outlook for tax legislation in view of the current national debt.
The elimination of the stretch IRA is expected to add $15.7 billion to the federal budget over the next ten years as baby boomers begin the pass away.
As you can imagine, this has tremendous estate planning ramifications for those wishing to pass-on wealth to their heirs. Now that the stretch is gone, here are three you may want to consider.
- Roth Conversions: This is an obvious one. Traditional IRAs may be tax-deferred, but they really should be called “tax-postponed”… until tax brackets are higher (remember the national debt and politician’s desires to spend tax dollars to gain reelection). If state inheritance taxes are an issue, a conversion could reduce the size of the estate and reduce tax exposure, too. A conversion may not be the right move for everyone. There are current tax bracket shift issues that should be considered.
- Life Insurance: Death benefits are generally tax-free, i.e., not included in the beneficiary’s income. Use distributions from the IRA to pay the policy and bingo – money goes to the kids and by-passes Uncle Sam. Depending on age and insurability, there are even advanced designs that could provide with tax-free income during retirement, as well. It’s not your father’s – or grandfather’s – life insurance anymore. It has become the ‘swiss army knife’ of financial tools.
- Charitable Remainder Trusts (CRTs): Use your IRA to fund a CRT. This allows parents to create an income stream for their children with part of the IRA while the rest goes to charity. While the CRT can grow assets tax-free, the kids do pay tax on the income withdrawn. There are two types: an annuity trust and a remainder trust. The first distributes a fixed annuity and doesn’t allow future contributions; the second distributes a fixed percentage of the initial assets and allows for continued contributions.
Naturally, you should discuss anything you’re considering with your financial, tax, and legal advisors before making any moves. It pays to plan.
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Jim Lorenzen, CFP®, AIF®
Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California. He is also licensed for insurance as an independent agent under California license 0C00742. IFG helps specializes in crafting wealth design strategies around life goals by using a proven planning process coupled with a cost-conscious objective and non-conflicted risk management philosophy.
The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.