Written by Matt Benson, CFP®
In the 2021 Winter Envisionary, I wrote about the significant change to the “stretch IRA” provision because of the passage of the SECURE Act [read article]. Planners have used this concept for decades to help preserve the assets of IRA owners and their beneficiaries. In thinking about recent client meetings, this rule change has given pause to how accounts are currently titled and what impact that may have to clients’ future planning.
My initial article took a detailed angle at what was changing and why. Where I thought we could dive deeper was on the strategies or conversations we should be having now that the rules are clear. I feel my dad saying, “well you’ve identified the problem, what are you going to do about it?” So, the challenge is that a non-spouse beneficiary of an IRA now must take the inherited portion of an IRA and distribute it entirely (and pay taxes at their rate) in 10 years after the IRA owner’s death. Let’s talk about some options for both the IRA owner and the beneficiaries to think proactively about this.
Let’s assume a husband and a wife, age 65, with 500K in each of their IRAs. Assume also they have two children in their 30s. In the post-SECURE Act world, these IRA owners have a goal to maximize the amount that gets to their heirs and minimize the tax burden placed on them. The parents in this situation could take the approach of annual Roth IRA conversions of their IRAs. They are not required to draw on their IRAs via mandatory required distributions until age 72, and presuming they are retired, they could very well have a low-income tax bracket. In the seven years leading up to RMD age, they could move a significant amount of their IRAs from tax-deferred IRAs to tax-free Roth IRAs.
Another strategy that could be employed is to change the beneficiary designation of the IRAs. If the spouse is made 50% and each of the two children are made 25% primary beneficiaries (as opposed to naming the children as “contingent”) this will create two separate 10-year distribution windows for the children as heirs. What we see most often is the spouse is the 100% primary beneficiary. That creates a situation where all the IRA assets are in the surviving spouse’s IRA resulting in one 10-year distribution window for the heirs.
Looking at this rule and its impact on the beneficiaries also presents planning opportunities. The rule states that the account must be liquidated entirely at the end of 10 years after the IRA owner’s death. That means there is technically an 11-year window to spread the distributions over. If the goal is to spread the income evenly over the allowable period, taking a partial distribution in the year of death, is a strategy that works. If a beneficiary inherits an IRA at age 55 in their peak earning years, it may make sense to defer any distributions to allow the inherited IRA to continue to grow tax deferred. If retirement at 62 is the plan, the rule allows for bigger distributions in those lower-income tax years. If the beneficiary has fluctuating income, coordinating the distributions from the inherited IRA in a “lump” fashion makes sense to maximize tax efficiency. We also have charitable strategies to offset large income tax consequences of distributions.
Every one of our clients’ situations is unique, with differing goals and objectives. As you can see from the list above, there are countless ways to plan proactively for this change in legislation. While this article describes very specific scenarios, it is really a retirement income planning discussion. We have written many articles on our industry and its lack of focus on thoughtful distribution planning. It is much easier to not put a plan in place because of the vast amount of information out there. If you’re feeling overwhelmed by all of this, never fear. We have a wealth of experience in this area and are always ready to help out.
This content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.