Some people who have been successful in saving for retirement have established a large enough nest egg to be able to create a legacy for their children, grandchildren or favorite charities. While tax-qualified retirement plans were designed to help people fund their retirement, they also serve a useful purpose for some in passing wealth to heirs, leaving them to wonder how to best leverage their tax qualified retirement plans.
For these individuals a common question is whether plan owners should take larger withdrawals and pay income taxes now, or whether they should take as little as possible during their lifetime under a “stretch” RMD concept, leaving an income tax burden for their heirs. Recent bills in Congress would greatly change the way inherited retirement plans work, making inherited retirement accounts “more taxing” to the heirs.
The Stretch is in Danger
Currently, retirement account owners can name their children or grandchildren beneficiaries of their IRAs and these young heirs can stretch out withdrawals over their own projected lifespans, enjoying potentially decades of extra tax deferred growth. This stretch planning has become a staple of planning especially for the affluent. However, momentum has been gaining over a proposal
first floated in 2012 by the Senate Finance Committee Chairman which would require most retirement accounts inherited by anyone other than a spouse, child while a minor, or disabled or chronically ill beneficiary to be distributed at a faster pace.
2019 could be the year where stretch planning meets its demise. Specifically, on April 2, The House Ways & Means committee passed with bipartisan support the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE) which requires distributions to be taken within 10 years. Shortly thereafter, the Senate Finance Committee reintroduced its version in the Retirement Enhancement & Savings Act of 2019 (RESA) which requires amounts over $400,000 to be distributed within 5 years.
It has been estimated that placing a limit on the stretch strategy will raise approximately $5 billion in revenue over 10 years. Of course, the projected revenue increase is due to the fact that the heirs (who are likely to be in their 50’s and 60’s) won’t be able to spread out withdrawals, meaning they are more likely to be pushed into higher tax brackets at a time when the heirs are often at their highest career income.
So, if limits on stretch are possible in the near future, what should financial representatives be doing now? Here are a couple of strategies worth considering:
Offset Beneficiary Income Taxes
Where your client’s retirement account beneficiaries are likely to be in a higher income tax bracket than the account owner, it may make sense to take larger withdrawals to help pay for a life insurance policy equal to the beneficiary’s projected income taxes. With this strategy, the beneficiary receives life insurance death benefits income tax-free and can use those funds to pay the taxes due on the inheritance. The type of policy (single life or survivorship) and the ownership structure will vary depending on the client’s specific situation.
Review Charitable Bequests
If you have a client that would like to make a bequest to a charity, it has long made sense for those individuals to leave their favorite non-profit their pre-tax IRAs. A charity can cash in a tax-qualified retirement asset such as an IRA at no income tax cost – and if there is a concern with estate taxes anything left to charity is excluded from estate taxation. This strategy can be taken one step further to incorporate an heir. Like the above situation it may make sense to use the retirement distributions to help pay for a life insurance policy equal to the value of the retirement asset that will be left to the charity. With this strategy both the charity and heir receive income tax-free benefits.
How Can DBS Help?
For more information about the recent proposals, contact DBS’s in-house Advanced Marketing Attorney, Business Development Director Terri Getman, JD, CLU, ChFC, RICP, AEP (Distinguished) at extension 230.