By Bill Monte, The Estate, Legacy and Long-Term Care Planning Center of Western NY
Well, it finally happened. After being passed in the House of Representatives by a 417-3 vote back in May, The Setting Every Community Up for Retirement Enhancement (SECURE) Act was attached to a broad appropriations bill at the end of 2019 and became new law.
This new legislation will have wide reaching effects on retirement and estate planning for most people, with the biggest change coming from the ending of the current Stretch IRA rules. Traditional IRA and other qualified retirement accounts are simply big bags of taxable income. We all know that when we remove money during our lifetime from those types of accounts that we pay current income taxes on that withdrawal. That will always be the case, but now the government is really coming after those who will ultimately inherit those accounts from us!
Prior to this law change, a non-spouse beneficiary of an IRA or defined contribution plans could stretch out Required Minimum Distributions (RMD’s) from the plan over their own life expectancy. However, starting on Jan. 1, 2020, if an owner of an IRA, 401(k) or 403(b) account passes away and leaves the account to a beneficiary other than their spouse, the beneficiary will only have 10 years after the year of death of the owner to distribute and pay taxes on the entire retirement account.
As I mentioned in a previous article, this is where IRA Maximization Planning utilizing life insurance will come into play and when properly structured and implemented, can create a dramatically better situation for the non-spouse beneficiaries, allowing them to fully escape the increased level of Federal and State income taxes that they will be faced with because of the new Stretch IRA rule changes.
Joint or “2nd to Die” life insurance for married couples or individual life insurance (for non-married) will undoubtedly become the primary “go-to” tax-efficient planning strategy to offset these income taxes and allow for the replacement of the retirement plan wealth that will be lost because of them.
Using life insurance for this purpose accomplishes so many positive things, the 4 main benefits being:
- The amount of money that you put into the life insurance legacy plan over your lifetime is substantially less than the much larger life insurance amount that your chosen non-spouse beneficiaries will receive 100% tax-free at your eventual passing. The immediate tax-free magnification that life insurance creates is quite dramatic.
- At your passing, it allows your Estate to recover and be paid back ALL of the income taxes that you paid on the withdrawals that you took from your Traditional IRA over your lifetime (both pre and post RMD).
- At your passing, it also allows you to recover and be paid back ALL of the income taxes that you paid on your Social Security income over your lifetime.
- Lastly, it gives your children, as the ultimate beneficiaries of your Estate, the tax-free capital to help them pay the substantial income taxes that will be due (at THEIR Federal and State income tax brackets) allowing your Traditional IRA to pass to them completely intact, avoiding erosion of your estate.
For those who have the available resources, either from discretionary income (non-needed RMD income being a common choice) or dormant investment assets or savings held outside of the Traditional IRA to use to fund the life insurance Legacy plan with, then this is a planning strategy that really should be fully explored. Doing so will fully negate the income taxes that your IRA beneficiaries will be confronted with again allowing your retirement accounts to pass to them completely whole.
The main caveat to be considered is that the funding of the plan (whether it be with one lump sum only or with deposits made annually) cannot have a negative effect on the individual or married couple’s desired retirement standard of living that they are currently enjoying. If it does, then this planning strategy is not appropriate and should not be implemented.
If you would like to learn more about the change to the Stretch IRA rules will affect the non-spouse beneficiaries of your IRA, please feel free to contact me at 585-721-2385.
The Estate, Legacy and Long-Term Care
Planning Center of Western NY
3445 Winton Place, Suite 115
Rochester, N.Y. 14623