The SECURE Act and IRAs – Estate Planning without the Stretch

Fundamentally, IRAs and qualified plans are designed to be retirement assets, not legacy assets. But the reality for many high-net-worth clients is that these plans, which were funded during working years, end up not being needed to meet retirement income needs, and are thus earmarked for heirs. Because these accounts were funded on a tax-deferred basis, they don’t receive a step-up in basis at the participant’s death, but rather distributions are taxable at the beneficiary’s tax rate. To help mitigate this tax bite, under prior law, clients would take advantage of special rules allowing these taxable distributions to be “stretched” over the lifetime of the beneficiary. 

Under the new SECURE Act, which went into effect on January 1, qualified plans must generally be distributed within 10 years of being inherited, essentially bringing the end to the stretch IRA concept. Now is the time to talk to your clients about this new law, especially those who do not need their retirement accounts to support their retirement.

Let’s look at a hypothetical example:

Megan and Harry, both 70 years old, are a married, retired couple. Harry has a $1M IRA growing at 5%. They do not need it for income, as they have enough money coming in through Social Security, pensions and other assets. Therefore, they were very excited to hear that with the passage of the SECURE Act, the Required Minimum Distribution (RMD) age is now delayed to age 72. Ultimately, they would like their IRA to go to their grandson, Andrew (their daughter is independently wealthy and will benefit from other parts of their legacy).

Yesterday’s approach:

Megan and Harry have their grandson listed as the beneficiary of their IRA. Prior to the SECURE Act passing, upon their death, Andrew could have received Harry’s IRA as an inherited IRA, and simply withdrawn RMDs over his lifetime. If his grandparents were to pass away today, he would have had an RMD of roughly $16k to withdraw based on his current age of 21. The remaining balance would stay in the IRA, and the power of tax-deferred growth and compounding would have happened over his lifetime, with Andrew taking his RMD annually.

Impact of the SECURE Act:

The landscape has completely changed with the passage of the SECURE Act, meaning today Andrew can only defer distributions for 10 years. This change affecting stretch IRA and qualified plans is projected to bring in $15.7 billion of tax revenue. For those clients who do not like the thought of Uncle Sam tapping into their qualified plan, life insurance may help with both the tax bite and their legacy goals.

Let’s look at some numbers:

If Harry withdraws only his RMD (at age 72) and then reinvests them at 3.5%, here are the numbers by the time they are 90 (we’re assuming their grandson Andrew will be in a 35% IRD tax bracket by that time):

Year	Age	IRA Value@5%	Reinvested RMD@3.5%	IRD@35%	Net IRA Value	Net to Heirs
20	90/90	$932,184	$1,008,436	$326,265	$605,919	$1,614,355

The data shown is taken from a hypothetical calculation. It assumes a hypothetical rate of return and may not be used to project or predict investment results.

What if instead, Megan and Harry took distributions out of their IRA ($26k/year) and used them to purchase a $1,689,722 Protection Survivorship UL life insurance policy? The numbers would look like this (RMDs still in force at age 72):

Year	Age	IRA Value@5%	Reinvested RMD@3.5%	IRD@35%	IRA Value	Death Benefit	Net to Heirs
20	90/90	$833,709	$232,319	$291,798	$541,911	$1,689,722	$2,463,952

This is a supplemental illustration. Not all benefits and values are guaranteed. The assumptions on which the non-guaranteed elements are based are subject to change by the insurer. Actual results may be more or less favorable.

The insurance policy can be owned personally by Megan and Harry, or in trust for the benefit of Andrew, giving them greater control over distributions after they are gone. The life insurance plan gives their grandson Andrew more options. For example, he could still take distributions from the IRA over ten years, using the tax-free death benefit to offset the tax due on the IRA. The bottom line is that from a legacy perspective, redeploying money from a qualified plan and leveraging it to purchase life insurance can help your clients with their wealth-transfer planning in light of the new SECURE Act.

For more on this strategy, or if you have any questions, call:
212-220-5563
Or email us at info@axg-advisors.com