Create your legacy and shift your tax dollars to your favorite charities while maintaining an income stream for you and your family.
Amidst the political debates and impeachment inquiry, a newly proposed federal legislation called the SECURE Act has passed in the House with major bipartisan support. It is currently held up in the Senate. Despite the postponement, many top pundits agree that there is a high probability of this bill passing.
Inside of the SECURE Act, one of the big changes expected is the elimination of a popular tax-deferral strategy known as the "Stretch IRA". Without the Stretch IRA, your heirs will be forced to withdraw your IRA in ten (10) years after the passing of you and your spouse.
Fortunately, we have alternatives to this possible forced 10-year distribution. This special report addresses specific estate planning strategies that may be helpful to consider.
For instance, a well-designed Charitable Remainder Trust (CRT) will replicate the favorable income tax benefits of the Stretch IRA, which is now threatened to become extinct. You can utilize a Charitable Remainder Trust combined with life insurance to replace the wealth passing to charity while providing your family with tax-free income.
Please feel free to read our special report for a deeper understanding of this and other effective estate planning strategies. Whether the Act passes or not, the concepts discussed below are viable tax strategies that may complement your existing estate plan.
What does S.E.C.U.R.E stand for?
Setting Every Community Up for Retirement Enhancement Act
The following is a breakdown of key changes and questions that will help you understand changes under the SECURE Act legislation, should it pass in the Senate:
Beginning Date for Required Minimum Distribution postponed until Age 72.
This will result in the retirement assets potentially growing income-tax-free for an additional 18 months. This change will increase the annual percentage payout upon the start date of withdrawals because the taxpayer's life expectancy will be shorter. In other words, more money for a shorter period, increasing cash flow for retirement.
Traditional IRA contributions may be made until the taxpayer stops working.
Under the current law, contributions to a traditional IRA must stop at age 70 ½.
Part-time employees must be covered by certain retirement plans.
This will significantly increase the number of employees that will be able to participate in a retirement plan. They will be more likely to sign up with a lower barrier to entry. Currently, a traditional IRA takes more self-motivation, and many employees fail to participate in a plan.
Elimination of the so-called “Stretch IRA” is the key provision that applies to most taxpayers.
To pass this legislation, Congress must come up with a revenue generator. Forcing a distribution from traditional IRA’s over 10 years or less versus allowing distributions over the lifetime of your children or grandchildren will generate a tremendous amount of income tax.
What is a Stretch IRA?
Instead of taking out your IRA over your remaining life expectancy, your heirs, who are younger than you, may take the IRA distributions out over their life expectancy (this stretches the payout to a much longer length of time). For example, if you give your grandchildren your retirement account, they can take it out over their life expectancy, which could be over 35 years (instead of your remaining life expectancy, which could be 11 to 17 years at the time of your passing).
What is a Required Minimum Distribution (referred to as the MRD or RMD)?
The required minimum distribution is the minimum amount of money you must take out of your IRA each year based on the tables set forth pursuant to the IRS rules. For example, at your required beginning date (which is by April 1 following the year that you attained the age of 70 1/2) you would need to take out approximately 3.5% per year in order to satisfy the required minimum distribution. Therefore, if your IRA is $500,000 at that time, then you would need to take out approximately $17,500.
What is “Life Expectancy” as it pertains to the so-called Stretch IRA and how is it calculated?
Life expectancy is simply how long the government/actuaries believe you will live based on the current assumptions. The life expectancy tables are set forth by the government pursuant to provisions that allow the treasury to update those tables from time to time. The last time the life expectancy tables were adjusted was in 2002. A revision of the life expectancy tables is currently underway.
What is the negative income tax aspect of the elimination of the Stretch IRA?
The primary downside of eliminating the Stretch IRA is the acceleration of the distributions of income, which will result in a much higher amount of income being taxed all in the first 10 years, as discussed above. By way of example, if you only needed to take out 3 1/2% of $500,000, then you would take out $17,500 in that particular year.
On the other hand, if you are forced to take out the entire IRA distributions in 10 years, the taxed amount would be much more significant. This forced distribution may push you into a higher tax bracket, plus you would be paying taxes in the earlier years, which means there are much fewer assets to continue to compound tax-free inside of your IRA.
What is a Charitable Remainder Trust (CRT)? What are the general benefits of a CRT?
A CRT is a split-interest vehicle that is permitted by the IRS under the Internal Revenue Code. The CRT allows you to donate money to charity while retaining an income stream for the income term or by providing an income stream for somebody other than the charity for the income term. The income stream can be for a maximum fixed term of twenty years or based on the lifetime of the beneficiaries named in the CRT.
If you try to create a CRT without using a split-interest trust, which is permitted by the IRS, you will not be able to obtain the charitable income tax deduction.
The following is a list of some of the benefits of establishing a CRT:
1. While the charity receives your legacy gift in the future, they are very interested in providing you with great recognition during your lifetime.
2. Making a gift to a CRT entitles you to a federal charitable income tax deduction, as well as a state income tax deduction, depending on your state. Florida does not currently impose an income tax.
3. If one contributes highly appreciated assets to a CRT, the trustee of the CRT may sell these highly appreciated assets, and the charity would not recognize any income tax, because the CRT is exempt from income taxation.
Therefore, the asset that you may have been holding onto for many years to avoid capital gains taxes may be sold and reinvested in a new portfolio.
4. The CRT is not subject to estate tax unless you are passing the remaining income interest to a non-spouse (e.g., a child or grandchild). If you pass the remaining income interest to a spouse upon your passing, you will be able to avail the unlimited marital deduction, and the remainder interest would move to the charity upon your spouse’s passing free from estate tax.
What are the benefits of a gift to a CRT instead of an IRA Beneficiary?
By transferring your IRA to a CRT, the IRA will not incur tax immediately.
Therefore, the IRA can be completely liquidated and reinvested in a new portfolio without immediate income taxation.
What are the negative aspects of this gift of an IRA to the proposed CRT?
While your heirs will receive a very nice income stream from the CRT, they will not be able to further access the principal (other than as part of the stated CRT distribution).
What are the benefits of a gift of cash to pay the premiums for a life insurance policy designed to replace the wealth that is passing to Charity upon the termination of the income interest in the CRT described above?
The increased post-income tax cash distributions from the CRT can be used to pay premiums on life insurance (designed to replace the wealth passing to the charities under the CRT).
Does it make sense to make the above-proposed gift of an IRA to a CRT if the Stretch IRA is not eliminated?
Whether or not the new legislation passes, the benefits provided by a combination of a CRT and life insurance are compelling and powerful!
In summary, the SECURE Act, if passed, may directly affect your IRA distribution planning (with the elimination of the Stretch IRA). Fortunately, we have alternatives to this forced 10-year required distribution.
Please remember that the CRT is only one strategy, and there are numerous other alternatives to offset the increased income tax exposure from the proposed 10-year payout.
Please consult with your financial advisors, estate planning attorney, and your accountant before making any major decisions regarding your IRA distributions.