The Setting Every Community Up for Retirement Enhancement Act – perhaps, like us, you flinch at this govspeak, but you’re likely familiar with it under its less arcane if still rather opaque name – the SECURE Act.
An active part of US law since the start of the year, this useful legislation is stirring the pot for retirement and estate planners nationwide. While many provisions make sense and improve the lot of our clients, others have led to headaches and long office hours – and it’s only just February.
For example, consider the changes to rules for inherited retirement accounts. Before 2020, heirs who received IRA, Roth IRA, 401(k) and other eligible accounts could stretch the required minimum distributions over their entire lives. This kept an ancestor’s memory alive, provided a nice boost to one’s lifestyle, and held the tax bill to a minimum. It was a pretty good system, but alas, all that has changed.
Under the SECURE Act, if you inherit a retirement account, you must withdraw its entire balance by the 10th anniversary of the original holder’s death (if the benefactors dies after 2019). In the wrong circumstances, this could mean a major tax bill for beneficiaries. This is why the government changed the rules: the original holder, who created and nurtured the account, enjoys the benefits with little hindrance. Heirs get their taste, too, but within limits. The IRS expects this to be lucrative for the state’s account, and seeing their point of view, it’s hard to fault them – not to say we won’t oppose them.
How should planners respond? One approach is simple enough in conception: when a client wishes to leave a qualified retirement account to an heir, pick a beneficiary in a lower tax bracket. One problem with the SECURE Act is the fact that recipients of such accounts, for a range of curious statistical reasons, are often in late middle age – the top-earning years of their careers. The Act’s requirement to drain inherited retirement accounts in only ten years can have a deleterious on their tax situation, particularly for affluent heirs.
If several children are involved, it’s a relatively straightforward matter of ranking them by income and tax brackets: those in the higher realms can inherit tax-off assets, while those lower down can receive the IRA. Tax matters still need to be calculated carefully so the low-bracket heirs don’t suffer a tax shock, however small – a lesser ache is no less severe to the bearer. Compensation can often be structured to cover potential difficulties, though it can be tricky to accurately project future earnings and tax vulnerability.
Grandchildren are a special case: often quite young at the time of their generous relative’s passing, they may be very low earners, indeed. They still only have ten years to take the required disbursements, but since they may be low earners/taxpayers – and in many cases, still in the process of higher education, which for advanced degrees can take many years – any tax penalty would likely be minimal.
To employ this strategy, as special clause must be inserted into the will, establishing the conditions under which the grantor’s assets, including cash, qualified retirement accounts and all other classes, will be passed in unequal shares to beneficiaries.
For example, take the case of a grantor with a $1 million IRA and $1 million in cash. His daughter is an investment professional in the 40% tax bracket; his son is a schoolteacher in the 20% bracket. Rather than split these assets and give an equal share to each child, it would be more tax advantageous to leave the cash to the tax-vulnerable, but savvy-investing daughter, and the IRA to the solvent but low-earning son.
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