Life Insurance Specialists


Stretch IRAs Eliminated Under SECURE Act; What do IRA Owners do Now?

Stretch IRAs were effectively ended by the Setting Every Community Up for Retirement Enhancement Act of 2019 (“SECURE Act”), signed into law December 20, 2019. They allowed funds to potentially compound income tax-deferred for decades for children and grandchildren (tax-free with a Stretch Roth IRA). Now, non-spousal beneficiaries must liquidate all accounts within 10 years (with some exceptions, below). Eliminating the Stretch IRA will create $15.7 billion in new tax revenue over next decade, according to the Congressional Research Service. Solutions: meaningful tax savings and control can still be achieved when planning with IRAs and retirement accounts, even considering the new rules.

What is a Stretch IRA?
A Stretch IRA is not a type of IRA; it is an estate planning strategy that allowed people to stretch out the duration — and therefore the tax advantages — of an IRA when it is passed to a non-spouse beneficiary, typically children and grandchildren. It allowed for continued tax-deferred growth of the IRA over the lifetimes of those younger beneficiaries; a very young beneficiary could stretch out distributions for decades.

How Does the SECURE Act Impact Stretch IRAs?

  • Under the old law, a Stretch IRA was available for all designated beneficiaries – individuals named on the IRA or plan beneficiary forms, and qualifying trusts.
  • Under the SECURE Act, the Stretch IRA is eliminated and replaced with a 10-year payout for all beneficiaries.

Who is Exempt from the SECURE Act?

  • Surviving spouses, who can do a trustee-to-trustee transfer of the IRA at the first spouse’s death, which effectively allows them to treat the IRA as their own.
  • Minor children (not grandchildren) under state law, extended up to age 26 if still in school. There is no age limit if the child is disabled. Once the minor reaches age of majority, the 10-year clock starts ticking.
  • Disabled beneficiaries who can prove that they are unable to work for long or indefinite periods of time.
  • Chronically ill beneficiaries who are unable to perform at least two activities of daily living for at least 90 days or require “substantial supervision” due to a severe “cognitive impairment.”
  • Non-spousal beneficiaries who are not more than 10 years younger than the original IRA owner (most likely applicable when leaving an IRA to a sibling or an unmarried partner).

Who Will the SECURE Act Impact the Most? 
The SECURE Act will generally impact owners of IRAs and qualified retirement plans (QRPs), with balances of $1 million more, who have other assets to live on and will not need the IRA assets for themselves.

What are the Potential Solutions?
According to Ed Slott, CPA, Elite IRA Advisor Group: “Life insurance moves to the top of the list as an estate and tax planning vehicle for the largest IRAs. IRA trusts will move to the bottom of the list (or possibly become extinct) under the tax rules.”

Why is life insurance, especially when owned by an irrevocable trust, such an ideal planning vehicle for large IRAs under the SECURE Act? Again, Ed Slott summarizes it well when he writes:

  • Life insurance can replace all the benefits of a Stretch IRA and IRA trusts.
  • Life insurance can create larger inheritances and allow more post-death control.
  • Life insurance can reduce taxes for beneficiaries because the death benefit is income and estate tax-free, if owned outside the estate.
  • Life insurance is a more flexible and customizable asset to leave to a trust.
  • Life insurance is simple, with no RMDs, complex tax rules, rigid stretch IRA trust provisions, IRA custodian issues, or tax on the proceeds paid to the trust.
  • A life insurance trust can be customized to simulate a Stretch IRA over any payout period desired, with the trustee having the power to keep the funds protected in trust without having to incur a trust tax (other than on annual earnings), or invade the trust for beneficiaries.
  • Individual or second-to-die life policies can be used, since the surviving spouse can do a spousal rollover and continue the IRA tax deferral for life.
  • Long Term Care is included in many life policies to protect other assets.
  • Life insurance provides leveraged wealth transfer, allowing more funds to go the eventual beneficiaries and with less tax, than if the IRA was left directly to the beneficiaries or to an IRA trust. 1

With these benefits of life insurance in mind, please consider the following solutions:

Solution #1:

Gradually Draw Down Taxable IRA to Fund Tax-Free Life Insurance

  1. IRA owner establishes an irrevocable trust for the heirs under desired terms and conditions and with asset and estate tax protection. The trust could be structured to allow for flexible distribution amounts like a Stretch IRA, with payments that could potentially be spread out over decades, as opposed to just 10 years or less.
  2. IRA owner takes unneeded IRA RMDs (or more) each year, pays income tax at current low rates, and gifts the net amount to the irrevocable trust. There is no tax on these gifts when using the applicable annual and/or lifetime gift exemptions ($15,000 and $11.58 million in 2020, respectively).
  3. Trustee invests the gifted funds in an insurance policy on life of the IRA owner (consider “second-to-die” design, if married).
  4. Life insurance cash account grows tax-deferred while the IRA owner is alive.
  5. Life insurance death benefits are paid income and estate tax-free to the trust for the heirs at the IRA owner’s death.
  6. Remaining taxable IRA/QRP balances can be inherited (drain in 10 years) or given to charity.

Solution #2:

Rescue Taxable IRA/QRP Funds with Discounted Life Insurance Transfer

  1. IRA owner establishes an irrevocable trust for the heirs under desired terms and conditions and funds it with a series of tax-free annual and/or lifetime gifts.
  2. Insurance on the IRA owner’s life is purchased and funded by the IRA/QRP, typically over a five-year period.
  3. Irrevocable trust purchases the policy from the IRA/QRP, typically at the end of the fifth year, using the IRS’s “safe harbor” discount.
  4. Life insurance cash account grows tax-deferred in the trust while the IRA owner is alive.
  5. Life insurance death benefits are paid income and estate tax-free to the trust for the heirs at the IRA owner’s death.
  6. Remaining taxable IRA/QRP balances can be inherited (drain in 10 years) or given to charity.

Solution #3:

Leave IRA Directly to Charity, Replace with Life Insurance for Family

  1. IRA owner establishes an irrevocable trust for the heirs under desired terms and conditions.
  2. IRA owner makes tax-free gifts of net IRA distributions to the irrevocable trust.
  3. Trustee uses gifts to purchase a life policy on the IRA owner with a death benefit equal to the projected IRA balance at life expectancy.
  4. IRA owner leaves taxable, non-stretchable retirement account balance to charity which is replaced for the heirs with tax-efficient life insurance in the irrevocable trust.

What are the Next Steps?

  • The SECURE Act has a major impact on how to plan efficiently with retirement accounts.
  • The time to act and review your plan is NOW.
  • Time is of the essence, especially when it comes to insurability and fluctuating tax laws.
  • Contact our office today so we can review your situation and customize a tax-efficient solution for you and your family.

1 Elite Advisor Network Newsletter, Ed Slott, December 17, 2019.

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