The nature of estate planning is that it is truly an ongoing process. It’s prudent to review and periodically update plans in light of numerous factors. Health, family changes, and changes in related laws are a few of the most common reasons you may want to update your plan. A recent law, the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, includes significant changes that could have an impact on your estate plan. It is therefore very important that existing documents be reviewed with the provisions of the new law in mind. The SECURE Act is quite robust. Following are just several examples where the SECURE Act intersects with some key estate planning opportunities and considerations.
Taxes on Inherited Retirement Accounts
One very key aspect of the SECURE Act is that it changes the requirements regarding the timing of distributions from an inherited IRA/tax-qualified retirement account going to a non-spouse beneficiary. The new law reduces the distribution period to ten years. This means most non-spouse beneficiaries must withdraw IRA/tax-qualified retirement plan balances after the death of the owner of the account within ten years. A prior law allowed many beneficiaries of IRAs/tax-qualified retirement plans, and properly structured trusts set up for those beneficiaries, to withdraw the account balances in installments spread over the designated beneficiaries’ lifetimes. The inherited retirement account assets could (and still can) be withdrawn more quickly, but the benefit of the prior law was that it allowed the assets to be distributed over the beneficiary’s life expectancy.
The ability to withdraw relatively small amounts from an inherited retirement account in the early years of a beneficiary’s lifetime resulted in the bulk of the IRA/tax-qualified plan remaining in the account for a significant period, growing on an income-tax-free basis. This tax deferral benefit made “stretch” planning very popular. For many of our clients, a significant portion of their assets are held in IRAs or tax-qualified retirement plans. Therefore, a significant portion of their current estate plan may be focused on maximizing the potential benefits heirs will receive from the inherited retirement accounts. An additional benefit of this planning was that it could maximize the amount left in inherited retirement accounts by choosing the order in which assets are consumed. It was common to suggest heirs balance distributions from taxable assets and nontaxable assets to provide the best tax result.
Planning for the New Ten-Year Rule
Planning centered around stretching out distributions will need to be revisited to consider the new accelerated ten-year distribution period. The result of this new law may be such that, along with your accumulated wealth, if you bequeath substantial IRA/tax-qualified retirement accounts to your adult children, you may be leaving them a large tax burden. As previously mentioned, these new rules also apply to trusts that are beneficiaries of retirement account assets. If you have a trust as a beneficiary or contingent beneficiary of your retirement accounts, it’s very important to review the terms of the trust. There can be negative tax consequences if the trust does not have the flexibility to distribute, out of the trust, the required retirement account distributions during the ten-year period.
The Extra Benefit of Leaving a Roth IRA to Your Heirs
Non-spouse beneficiaries who inherit Roth IRAs will also have to take the money out of the retirement account within ten years, thereby losing the benefit of tax-free growth for the prior stretch period. However, since there is no tax impact for Roth IRA distributions, it may be advisable to wait to distribute the full account in the tenth year and enjoy a full ten years of tax deferral. Estates containing Roth IRAs clearly have an advantage over estates with only non-Roth retirement accounts. Most heirs will likely withdraw one-tenth of a non-Roth retirement account every year for ten years to spread out the tax impact. Depending on your situation, a Roth conversion might be a good option not only to minimize your heirs’ tax burden, but also to sustain the growth of your retirement nest egg, thus increasing your ultimate legacy. This planning should take into consideration your current and future tax brackets, as well as the future tax brackets of your heirs.
Gifts, Loans, and Low Interest Rates
The COVID-19 pandemic and the resulting market volatility, is having a significant financial impact on the value of certain assets. Depending on the type of business, the value of many small businesses has dramatically declined. In addition, some real estate has seen significant decline in the value. Hopefully, these reductions are temporary and will revert to normal levels when the pandemic subsides. Until then, you may consider transferring reduced value assets to your heirs at the current lower values. These transfers, whether by gift or loan, could allow for potentially significant growth, outside of your estate, and the opportunity to avoid gift and estate tax when values do return to a higher level. In addition, interest rates used for intra-family loans and more sophisticated estate planning techniques (e.g. Grantor Retained Annuity Trusts) are at an all-time low. In summary, this may be a good time to make gifts and/or loans due to the current suppressed values and interest rates.
Next Steps
While many unpredictable factors related to the pandemic remain, acting ahead of an economic recovery could allow you to leave more of your hard-earned wealth to your beneficiaries and lose less to taxes. To learn more about estate planning opportunities during this time, please contact your CCM advisor to engage our team in your situation. Our team looks forward to helping you navigate the intricacies of the SECURE Act. We are happy to assist in applying the related considerations and opportunities to your estate plans such that they are best positioned to carry out your wishes and intentions.
For more content on the SECURE Act, read a previously published piece by Kevin Koski, CPA, Principal Tax Advisor, How the SECURE Act Could Impact You.
NOTE: The information provided in this article is intended for clients of Carlson Capital Management. We recommend that individuals consult with a professional adviser familiar with their particular situation for advice concerning specific investment, accounting, tax, and legal matters before taking any action.