After establishing an estate plan, it is essential to regularly review it in its entirety to ensure that your will or trust still aligns with your long-term goals and expectations. While this can be done on an annual or quarterly basis, it is also important to return to your plans after a major life event—or a change in government regulations.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act was initially passed at the end of 2019, with many of the new rules immediately going into effect on Jan. 1, 2020. However, starting this year, a new mandate takes effect, and how the IRS is interpreting it may impact you and your beneficiaries moving forward.
If you created your estate plan prior to the creation of the SECURE Act, read on to learn how it may alter your strategy as well as which tax-efficient option may be available to you.
An Overview of the SECURE Act
The SECURE Act was first signed into law by former President Donald Trump in 2019. When the act was initially created, its goal was to expand retirement options for employees while also simplifying the process of offering employer-sponsored plans for businesses.
In an effort to help Americans better prepare for retirement, the new regulations introduced several positive changes, including broadened eligibility for 401(K) plan participation while also offering small-business owners a tax credit for starting workplace retirement plans, as reported by Kiplinger. However, in addition to these benefits, the SECURE Act also created new complexities for anyone who had already established an estate plan. For many investors, this has led to uncertainty as to whether their existing strategies would still work for them and their loved ones.
How Inherited IRAs Will Change
Before the start of 2020, the beneficiary of an inherited individual retirement account (IRA) was able to defer taxation over their lifetime by taking required minimum distributions based upon the age of the beneficiary. This essentially created a “stretch IRA” in which the beneficiary could keep the money in place for years, allowing it to grow continuously. Although the account inheritor still had to pay income tax on withdrawals, they were able to spread the distribution for decades.
Now, that timeline has been significantly reduced.
As Yahoo Finance explained, the SECURE Act has officially put an end to stretch IRAs. As of 2022, all of the money in an inherited IRA must be withdrawn within 10 years of the death of whoever created the account. These funds can be drawn from incrementally or all at once in the form of a lump sum. For instance, you could entirely remove the funds from the inherited IRA and invest them somewhere that required minimum distributions (RMDs) do not apply, like a Roth IRA.
However, the end of stretch IRAs is not the only concern the SECURE Act has created. Now, if an account owner passes after turning 72 and had already begun taking RMDs, the beneficiary is required to take out a yearly withdrawal in addition to removing all of the money at the end of the 10th year.
For those with an established estate plan, this means you can not push back the tax bill for a full 10 years for your children or grandchildren if you live past 72. The only exceptions to this rule are cases in which the beneficiary is a surviving spouse, a child under the age of 18, or a disabled or chronically ill beneficiary who is up to 10 years younger than the deceased retirement account owner.
A Potential Alternative
As a result of the SECURE Act, an account beneficiary will now have to determine the best strategy for withdrawal, based upon their own income and tax bracket. Additionally, they will need to take out larger amounts of money at once—while also being taxed on that larger distribution.
One strategy to navigate the impact of the SECURE Act is to instead use a Roth IRA. As Kiplinger explained, Roth conversions transfer the tax liability to the account owner, which essentially means you will owe on any taxes converting, “prepaying” the bill for your heirs. This can be a tax-efficient way to reduce the strain on your beneficiary, especially if the conversion occurs early in retirement.
In addition to the benefit of tax-free withdrawals, a Roth IRA has an added bonus for heirs: They can leave the funds in the account to grow tax-free for 10 years. Because of that, their inheritance could be even more substantial than originally anticipated.
It is important to note that estate plans are not a one-size-fits-all strategy. When determining which makes the most sense for you as well as your beneficiaries, be sure to consider your long-term goals both during your retirement and after you pass on your assets to your loved ones. Although a Roth conversion is often the most tax-efficient option, some investors may want to look toward other solutions, such as prepaying their tax bill using a life insurance policy.
Evaluate and Adjust Your Estate Plan
Continuously reviewing and updating your estate plan over time has always been a best practice. However, it is more essential than ever before to evaluate your existing strategy and ensure it still achieves you and your family’s desired financial outcome(s), while remaining in compliance with the SECURE Act.
If you are in need of further guidance when it comes to this or other estate planning issues, you should consider working with a financial advisor. For additional information surrounding the SECURE Act, or if you are looking to learn more about creating an estate plan of your own, please contact us today.
How the SECURE Act May Impact Your Estate Plan
Sources:
Foster Friedman, J. D. (2020, August 28). Secure act: How it can affect your estate planning. Kiplinger. Retrieved March 27, 2022, from https://www.kiplinger.com/retirement/601315/secure-act-how-it-can-affect-your-est ate-planning
Geier, B. (2022, March 24). Why the secure act could make you change your estate plan in 2022. Yahoo! Finance. Retrieved March 28, 2022, from https://finance.yahoo.com/news/why-secure-act-could-change-202257695.html
Stewart, J. (2022, March 3). Getting around the stretch ira block. Kiplinger. Retrieved March 27, 2022, from https://www.kiplinger.com/retirement/retirement-plans/iras/604304/getting-around-t he-stretch-ira-block
The views expressed represent the opinion of Apex. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment.