We are all aware that substantial changes are on the horizon when it comes to financial planning. Specifically, when it comes to retirement income planning. Whether it is taxes, inflation, the national debt, or the market, big changes such as the SECURE ACT and other new IRA rules are coming, and everyone knows it. This 12+ year run we’re going through cannot sustain. I understand COVID had a major effect on many Americans Retirement plans but even as we are recovering, we still must prepare for the fiscal changes coming our way.
When I am speaking to new clients a common question early on is, “what about all the IRA Rules changes that are coming?” My answer to that is, “the biggest IRA rules change has already occurred and most have not prepared for it!”. It is called the Secure Act!
The Setting Every Community Up for Retirement Enhancement (SECURE) Act has made big changes to retirement plans and the way distributions are handled. Two of the biggest changes that may affect you are:
Under the old law, participants were required to begin taking RMDs at 70 ½. Now, the age at which RMDs are required is 72. In addition, due to the COVID-19 pandemic, those participants who had RMDs due in 2020 were able to skip their distribution for that year, which has since expired as of 2021. These RMD changes are perceived as a benefit by most participants and their advisers.
Not so fast! I don’t mean to preach but this reminds me of JOB 1:21 The Lord Giveth and Lord Taketh Away. In this case, the IRS gives a benefit such as allowing RMDs to be taken a bit later at age 72 but what do they ask in return?
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Stretch IRAs, on the other hand, are a different story. Under the previous law, a non-spouse beneficiary of an IRA could choose to take distributions over his or her lifetime. These “stretch” payments were based on the beneficiary’s life expectancy. If there were still funds in the account at their death, they could be passed on to the next generation. This strategy provided a tremendous tax deferral opportunity while allowing the account to continue to grow.
The SECURE Act has eliminated the stretch IRA for all but a handful of exceptions:
Unless a named beneficiary qualifies for one of the exceptions, he or she is required to liquidate the account fully within a 10-year period. This can be done over time or all at the end of the 10th year. There is no systematic RMD requirement.
It’s important to note that beneficiaries of a participant who died in 2019 still have the stretch option available, as do beneficiaries already in a stretch strategy.
Qualified money such as IRA’s typically is the most highly taxed money upon the death of a client. With the loss of the stretch, one of the great planning tools for clients just disappeared. Tax deferral over 20, 30, or 40 years was a huge benefit.
Families accumulating large RIA’s and 401K’s were able to leave a legacy plan that would have benefited their grandchildren, but that tool is now gone. The IRS allowed RMD’s to be delayed until 72 but they took away the lifetime stretch provision! Not even close who got the short end of that stick!
So as a planner we now must be creative to help our clients continue to create the legacy plans they have built within the new guidelines.
Let’s put a bookmark in the IRA discussion for a moment and look at taxes. The table below shows the federal marginal tax rates for 2020. This is the rate at which the last dollars coming into a household are taxed. The top marginal rate of 37% is historically relatively low.
With over $3.8 trillion added to our national debt this year, our total national debt will exceed $26 trillion. To put that in perspective, according to justfacts.com, that equates to $77,268 for every man, woman, and child in the United States, or $198,063 for every household!
At some point in the not-too-distant future, revenues (taxes) will need to increase—if only to cover the rising interest liability. But who will that affect? According to the Tax Foundation, the top 50% of wage earners pay about 97% of the total taxes. It’s unlikely that will change in the future.
What will have to change is the rate at which they pay. The chart below shows the historical top marginal income tax rate from 1913 to the present. How high the marginal rate will grow is up to Congress. That alone should scare you.
Patriot Advisory helps clients plan for a 20 or 30-year retirement. Tax planning is just as important as income planning.
Similarly, estate taxes today are at a historical low. In 2017, the estate tax exemption was $5,490,000 per individual. With the 2018 tax law, this exemption was increased significantly and today is $11,580,000. This increase, however, is slated to expire after 2025, forcing the exemption back down to 2017 levels with an inflation adjustment. This will immediately create estate tax problems for millions of households.
The point is that taxes of all types will increase in the future and pre-retirees have a relatively small window of opportunity to adjust to the changing landscape.
The point is that taxes of all types will increase in the future and pre-retirees have a relatively small window of opportunity to adjust to the changing landscape.
Now, back to the bookmark. Let’s say you have a large IRA; you most likely fall into one of these categories:
If you are in category 2 or 3 you need to speak to a financial advisor. Tips on how to find one below 😊
We suggested a strategy for $300,000 of the remaining IRA funds to systematically (over 10 years) move $30,000 annually from Bank A (the IRA) to Bank B (an over-funded IUL policy). IUL stands for Indexed Universal Life Policy. This provided an immediate tax-free death benefit of about $500,000. At the end of 10 years, the $300,000 of highly taxable IRA funds became over $300,000 of tax-free, increasing cash value. This bucket could be tapped for emergencies (like a new bass boat). If he lived until 90 and never tapped the account, the tax-free death benefit to his kids would be over $1,000,000.
The moral of this story is we were able to turn taxable dollars (the IRA) into two tax free buckets of money:
Sound too good to be true? Well, it is not, the only catch is he was relatively healthy enough to qualify for the life insurance vehicle (the IUL). So, if you have “fair” health for your age this concept is an option. This covers category 2, those who have an IRA and need some of the funds for retirement as well as want to leave a legacy. They need the IRA to do both.
Finally, let’s look at category #3, high net worth individuals who have large IRA’s and do not really need it. These fortunate souls have other sources of assets from which to draw. The Bank A/Bank B strategy works the same here. Understanding the ticking tax time-bomb of an inherited IRA, we asked, “If we could double the inheritance to your kids (charity, etc.) and make it all tax-free, would you be interested?”
The strategy here is not maximizing cash flow, rather it is guaranteed death benefit to age 120. In the case below, we had a client, also age 60, who had a $500,000 IRA in which his children were the named beneficiaries. He had plans to implement a stretch strategy to provide lifetime income and defer taxes. That opportunity is now gone.
To illustrate the concept, we’ve developed a simple tool to show the benefit to the client. We project the IRA’s values into the future here using a 5% growth rate. Then, apply the heir’s assumed tax rate to arrive at a net inheritance at various points in time.
In the second box, we take the $500,000 IRA and bleed it down over 10 years at today’s favorable tax rates. (We can always accelerate the process if a tax increase is imminent.) We set aside enough money to cover the tax liability and move the remainder to Bank B, a no-lapse IUL policy. This would generate about $1.2 million in tax-free death benefit to the children. The policy could be held in an irrevocable life insurance trust (ILIT) to keep the death benefit outside Dad’s estate.
It’s a pretty compelling story, but what if we build in some future tax increases? In the boxes below, we assume a minor income tax increase to 40%. We also build in the estate tax liability at 40% assuming the expiration of today’s rates in five years.
The story gets even better for the client. Bank B is the obvious choice. This concept is also driven by a life insurance engine.
As you can see there continues to be opportunities to create a legacy plan with qualified funds. The game has changed a bit and more than ever you need to plan ahead of time. With the old stretch provision, you could have left the planning portion to your beneficiaries. They could have easily just chosen the stretch option over their lifetime when they received the inheritance of IRA funds. Now your beneficiaries have only two options when receiving an inheritance of IRA funds:
Remember these options have taken multi-generational legacy planning off the table.
However, using life insurance benefits to your advantage can create tax free income for yourself as well has a tax-free inheritance to any beneficiary you wish. But YOU have to plan into action.
So if you fall into one of these categories reach out to us at Patriot Advisory Group for some guidance on IRA planning and do a bit of “banking”.
As you can see, Patriot Advisory Group offers unique a planning approach when approaching changes in IRA Rules. We understand the unique challenges facing you and have the experience and ability to provide sound financial advice. Get started by clicking this link to request your complimentary one-on-one discovery call to quickly find out how the new IRA Rules affect your unique situation.
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