What changed as of the Secure Act?
Prior to the Secure Act, if married, it was most common to have your spouse as primary beneficiary and your children as contingent beneficiary. If you passed, in the vast majority of cases your spouse would be advised to transfer your IRA into their own and name the children as primary beneficiary.
This was logical as ONLY primary beneficiaries were allowed this special lifetime stretch provision. If your spouse failed to transfer it to her, and then passed, the children would technically be contingent beneficiaries and would need to empty the IRA (and lose its protections) within 5 years. This mistake of not transferring the IRA to the spouse had been the cause of many lawsuits against “so-called” advisors that were unfamiliar with those rules.
The Secure Act eliminated the stretch IRA, eliminated mandated annual distributions, and instead imposed a mandatory 100% distribution after ten years₂.
Before the Secure Act, Living Trusts, aka Revocable Living Trusts and several other aliases were utilized for many important reasons. The most common reasons included an elimination of probate for assets held within the trust, they kept the financial affairs private, they controlled or restricted distribution where that was required, and a very important one for us as advisors – in most states they provided the same or similar creditor protection found in the held IRA assets previously mentioned.
A wise person might ask the question: Since new funds cannot later be deposited into the trust by the heir, and the IRA must be emptied in ten years, where does the heir deposit that distribution and what happened to the creditor protection benefits.
Frankly, the creditor protection benefits would disappear. The only place to put the funds is in their own name or their own trust which does not have the same protections in place.
Outcome: Anyone with any significant IRA or qualified account assets should be considering amendments to their Trusts, or creating one if one does not exist.
Let us take a hypothetical situation. You leave $1,000,000 in an IRA for your only child. Distributions are not required for ten years, and they do well financially on their own to not need the funds. Ten years later, using a 7.2% average growth rate, the IRA is now $2,000,000 and forced to be distributed.
The $2,000,000 gets added to their income for tax purposes and depending on the federal brackets then in place as well as state taxes, perhaps as much as 45% of it is gone to taxes leaving $1,100,000. Your child then deals with a divorce and loses half of that – leaving $550,000 of your hard-earned money a decade later.
Possible solutions given proper tax and legal advice:
[1] You convert the IRA over the next few years and with proper planning, only lose 30% to taxes, hypothetically leaving $700,000 in your Roth IRA₃.
[2] Ten years later at 7.2% it doubles to $1,400,000.
[3] Your trust is modified and updated for new rules allowing the mandated ten-year distribution of the Roth IRA to be placed within the trust and retain creditor protections. Your child has $1,400,000 instead of $550,000.
This rudimentary example shows the incredible need for tax and legacy planning today. Especially given the ever-changing tax environment we face.
Reach out to the Tax Plan For Wealth team to see if our services can provide planning benefits for your family. A complementary consultation can be scheduled here:
