If financial advisors want to reduce the odds that new estate planning provisions included in the 2019s Secure Act will result in client assets going to the Internal Revenue Service rather than their intended heirs, they should review possible workarounds now.

“It really takes somebody to sit down, you know, think about the dynamics of what you own, and do some serious planning, more than in the past,” says Glenn DiBenedetto, a CPA and director of tax planning for the New England Investment & Retirement Group.

That’s because provisions of the act eliminate so-called “stretch” distributions that owners of IRAs and other qualified retirement plans use to direct assets to heirs other than the account holder’s spouse. With the change, the federal government stands to raise some $15.7 billion over the next decade, according to the Congressional Research Service.

The Setting Every Community Up for Retirement Enhancement (Secure) Act of 2019, signed into law in December, increased the age for required minimum distributions (RMDs) from deferred retirement accounts from 70 1/2 to 72.

And although that provision captured much attention, the law also altered the rules for when a retirement account owner dies and a beneficiary other than their spouse inherits those assets.

Before the new law, an heir could “stretch” withdrawals from the account over their lifetime. A 50-year-old whose parents died, for example, could withdraw the money over decades and not bump themselves into higher income brackets. But under the SECURE Act, that same beneficiary must drain all assets from the inherited account within ten years of the owner’s death.

This could quickly kick a growing number of mass affluent individuals who inherit such accounts into tax brackets closer to those of millionaires. Consider that Fidelity Investments reported in February that the number of people with $1 million or more in their 401(k) increased to a record 233,000 in the fourth quarter of 2019, up from 200,000 the previous quarter. Fidelity also reported that the number of IRA millionaires increased to a record 208,000 in the same time period, an increase from 182,400 in the previous quarter.

If one child is the sole beneficiary of their IRA millionaire parents' accounts — and fails to get good advice — they could see their eligible taxable income increase by $200,000 on average each year for the next decade.

So, what good estate planning advice can FAs offer IRA millionaire clients?

First, clients who have reached the penalty-free age for withdrawals — 59 1/2 for IRA accounts — should take out as much as possible each year to max out their income while staying in their existing tax brackets, DiBenedetto says.

If account holders then want to bequeath that money to beneficiaries, they can sock it away in a non-qualified account. Although they may generate capital gains, their heirs will be able to withdraw money at their own pace and likely face lower taxes on any withdrawals since they will be able to take advantage of the step-up allowances for inherited assets. Moreover, they will pay taxes at capital gains tax rates, which for many are lower than their income tax rates, according to DiBenedetto.

Alternatively, FAs should recommend clients convert as much of their IRA or 401(k) assets as possible, without swelling the account owners’ tax bill, into Roth accounts. Those accounts still allow for tax-free distribution to beneficiaries, DiBenedetto says.

Clients who wish to pass on their wealth to their children may also consider using qualified charitable remainder trusts.

Such structures “mitigate the impact of the 10-year rule,” says Mike Repak, a vice president and senior estate planner at Janney Montgomery Scott.

With a charitable remainder trust, an IRA or 401(k) account holder can name themselves or heirs as the recipients of payments for up to 20 years, or the lifetime of one or more of the non-charitable beneficiaries. The remainder, which must be at least 10% of the account’s assets at the time the trust is created, goes to designated charities.

For example, for a $1 million IRA account, the strategy calls for giving $900,000 to the heirs and $100,000 to a charity.

“It can be very attractive, in the case of people who already have a philanthropic inclination,” says Repak. “[T]his is a way to make a very cost-efficient contribution to charity and still let the kids get some benefits from that IRA,” he says.

The charitable remainder trust eliminates the capital gain tax on the sale of low-basis assets. But, notably, it does not eliminate the income tax on the income the non-charitable beneficiaries collect. At the same time, it allows the account to pay out over more than 10 years so beneficiaries can better manage their tax bracket status.

“Middle-class people may want to take a look at this [charitable remainder trusts], especially if the kids have been successful in their own right so they don’t need every nickel in the IRA,” Repak says.

Neither Repak nor DiBenedetto expect Congress to reverse its stance on the “stretch” feature of inherited tax-deferred accounts anytime soon.

However, if a Democratic presidential candidate focused on income inequality wins the 2020 election, the stretch elimination provision in the act might get a second look. Such candidates may be sensitive to the fact that eliminating the “stretch” provision could cause middle-class beneficiaries to pay higher estate taxes, on average, than high-net-worth beneficiaries.

The inheritance tax for non-retirement assets currently allows for $11.58 million of assets, per individual, outside of qualified retirement accounts to pass to heirs untouched by the federal government.

Repak can even imagine Congress allowing tax-free use of deferred account withdrawals for long-term care needs, such as helping parents or children, Repak says.

“When it comes to long-term care planning costs, everyone’s a Democrat, I don’t care how Republican you are about other things,” Repak says. “They want to know how they can take advantage of whatever programs are out there, and how they can take advantage of whatever, let’s call them loopholes, that the law allows.”

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