The impact of the SECURE Act 2.0 has created a game change for high-net-worth clients. The Setting Every Community Up for Retirement (SECURE) Act requires beneficiaries of inherited IRAs to withdraw all assets of the IRA account within 10 years, in most cases. This can create a significant income event resulting in giving back most of the income tax benefits accumulated over the years. Post-death control is also minimized while the resulting lack of asset protection increases.

Previously, inherited IRAs could be distributed over the life expectancy of the designated beneficiaries. In many cases, the beneficiaries were children or grandchildren of the IRA owner that meant distributions, and the income taxes on those distributions, could be potentially spread out over several decades. This strategy was commonly referred to as the “stretch IRA” technique. Now, that stretch-out is limited to just 10 years.

Certain beneficiaries, referred to as “eligible designated beneficiaries (EDB),” are exempt from the 10-year rule:

• Spouses
• Minor aged children until age 21
• Chronically ill and disabled children
• Beneficiaries no more than 10 years younger than the IRA owner

This is a dramatic change that will create a need for alternative planning strategies to transfer wealth to future generations on a tax efficient basis. Additionally, there is loss of asset protection when beneficiaries take ownership of IRA assets after the 10 years. The lack of post-death control means the assets will now be subject to creditors, divorce, and ill-advised decisions.

Beneficiary Classes for Distributions

IRS modified their initial ruling on inherited IRA distributions by splitting Non-EDBs into two groups. How these beneficiaries can receive required minimum distributions (RMD) are based on the death of the IRA owner.

One group would be comprised of Non-EDBs who inherited from retirement account owners who died prior to their required beginning date (RBD). This group of beneficiaries would have the option to receive the full balance from the IRA within ten years after the death of the IRA owner but wouldn’t be required to take pre-SECURE Act RMDs for the first nine years. The other group, Non-EDBs who inherited from retirement account owners who died on or after their RBDs, would be subject to both the 10-year rule and RBDs for the first nine years.

The proposed regulations also clarify who can be considered an EDB. They provide that the account owner’s children are considered minors until they reach their 21st birthday. This means that minors would use the “stretch” RMD rules until their 21st birthday, and then be subject to the 10-year rule and potential continued RMDs (if the decedent died before reaching the RBD).

Planning Strategies

Post-death control is a top concern for high-net-worth clients. They want to be sure these assets end up with their intended beneficiaries.

Consequently, there is now a need for a Plan B to manage the income tax and asset protection implications of this dramatic change in the regulations.

Some of the common strategies being considered are

• Roth Conversions
• Reviewing IRA Trusts & Beneficiaries
  

Roth conversions provide a trade-off for paying income tax now and receiving the proceeds income tax-free later. The asset will still be owned outright by the beneficiaries without additional planning. It will also still  be included in their estate; this becomes more relevant as estate taxes are expected to increase while the estate tax threshold is expected to decrease.

IRA trusts provide asset protection benefits, but do not address the significant income tax event that occurs at the end of the 10-year period.

Other Techniques Available to Mimic the Stretch IRA

There are two techniques that can mimic the stretch IRA. They also have potential income tax, estate tax, and asset protection advantages over the traditional “stretch” concept.

Alternative Technique #1: Modified Roth Conversion

Below is a study comparing a more traditional approach clients take by differing growth then taking  RMDs at age 73 to life expectancy, passing the remaining balance to their beneficiaries at age 95.

In an alternative technique referred to as a “modified Roth conversion,” the after-tax proceeds are reallocated to an income tax efficient plan using life insurance over a 10-year period. Alternative periods can also be used. The policy is owned inside an irrevocable life insurance trust (ILIT), allowing the proceeds to pass income and estate tax-free.

Using the ILIT enables this technique to mimic the traditional “stretch” strategy.

Attached are two hypothetical scenarios based on a $3,000,000 IRA illustrating the following:  

• A more traditional approach of taking RMDs from an IRA from age 73 to 95 vs  
• An IRA paydown over 10 years at age 60 funding an income tax efficient account through a whole life survivorship insurance policy 

Note:

IRA assets grow @ 4%; RMDs taxed @ 45%; RMD account grows @ 5%. Estate tax rate 40%.

Legacy values in scenario #1 included in the estate vs outside the estate in scenario #2.

Summary Points of Alternative Strategy:

• Over 50% less taxes; tax savings over $2 million
• More assets passed on to next generations outside the estate  
• Gain asset protection from creditors, divorce, bad investment decisions and other potential unexpected wealth eroding events 
  

Access detail to scenario #1 & #2 summaries

Access detail to scenario # 2

Alternative Technique #2: Charitable Remainder Trust Coupled with Asset Replacement Trust

The other, more comprehensive technique, caters to those who have some charitable intent. This strategy mimics the traditional “stretch” two ways: through using a charitable remainder trust (CRT) and a wealth replacement trust (WRT).

Using this approach, the donor names a CRT as beneficiary of an IRA, which converts the assets to pay an income stream to the child beneficiary of the CRT for a specified period of time (maximum period, 20 years). When the CRT terminates, the assets pass to the charity. Then, through the use of an ILIT, the life insurance replaces assets that don’t pass to the donor’s children or grandchildren due to the use of the CRT, where the assets are ultimately passed.

The client can substantially mitigate most of the income taxes typically paid on these assets (other than the CRT distributions) making this an extremely tax efficient strategy to pass assets. The client also receives an estate tax deduction for the remainder interest passing to the charity, adding to the tax benefits of this technique. The client may object to this strategy however, because their family is being “disinherited” by the charity receiving the IRA proceeds; that’s where the wealth replacement trust comes in.

While alive, the IRA owner may use some IRA distributions or other assets to fund the ILIT to pay the policy premiums. In addition, or alternatively, the child can use some or all of the CRT income stream to fund the ILIT to pay premiums. For example, if a donor would normally have left an IRA to grandchildren(which is no longer advantageous under the SECURE Act due to the 10-year rule), or the donor would expect under the old “stretch IRA” rules that there would be IRA money left at the child’s death that would go to grandchildren, the donor can leave the IRA to a CRT at death, and the child beneficiary of the CRT can fund an ILIT that owns a life insurance policy on the child that will benefit the grandchildren when the child dies and the remaining assets in the CRT will pass to charity and not to the grandchildren.

See attached Flow Chart below:

Planning Abstract
Below is the summary of the two techniques that can mimic the traditional stretch IRA strategies for the high-net-worth clientele with enough other assets to live on, passing on the higher taxed qualified plan or IRA accounts to future generations for legacy planning.

Two Techniques

• One strategy caters to those with charitable intent 
• The other strategy caters to those who do not have charitable interests(also referred to as a “modified Roth conversion”)
  

CRT With a Wealth Replacement Trust (WRT)

The CRT and WRT strategy provide two “stretch" opportunities for the client:

• Client receives income and estate tax benefits passing taxable assets to charities.
• This can benefit multiple generations (not available under the new regulations).
• The family is kept whole by funding the WRT.

Tax Benefit Summary

• Significant income tax benefits are available compared to the traditional approach, starting RMDs at age 73.
• The life insurance proceeds paid to the life insurance trust are received income and estate tax-free. 
• The insurance trust recreates the stretch IRA technique, benefiting generations beyond 10 years, for multiple generations. Asset protection is maintained throughout.
• Trust assets remain outside the estate and any future estate taxes.
• Income distributed to beneficiaries from the trust can also be received income tax-free.
  

Kenneth A. Horowitz, CLU® ChFC® RICP®  AEP®, entered the financial services and life insurance business in 1989 after a short career in the commercial real estate finance business with a leading NYC based commercial bank.  He became affiliated with the Guardian Life Insurance Company of America, New York, NY as a Field Representative with the Compain Anderson Group and went on to qualify for the company’s prestigious Awards Club for many years. After merging with another NYC based Guardian agency in 2000, Strategies for Wealth, Ken’s services grew more comprehensive by providing clients a distinct financial planning process.  His commitment to the financial services business is exemplified by qualifying as a Chartered Life Underwriter (CLU), a Chartered Financial Consultant (ChFC), Retirement Income Certified Planner (RICP), as well as earning a Series 7. Ken’s specialization includes helping accountants deliver more value to their clients by offering more proactive and holistic strategic planning services. He has also given his time to help various charitable and local organizations.  Some of his affiliations include: Board member and President of the Bergen County, N.J. Estate Planning Council; Head of the N.J. Chapter of Hofstra University Alumni Association; Executive Board Member of Albert Einstein College of Medicine; Penn State Parents Association; Y-JCC of Bergen County Board member; The Loomis-Chafee Alumni Association; and member and coach of the Woodcliff Lake Basketball Association.

Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS). Securities products and advisory services offered through PAS, member FINRA, SIPC. Financial Representative of The Guardian Life Insurance Company of America® (Guardian), New York, NY. PAS is a wholly owned subsidiary of Guardian. Integrated Benefit Consultants is not an affiliate or subsidiary of PAS or Guardian. CA insurance license # 0C37308. The information in this presentation is designed to be general in nature and for educational purposes only. All scenarios mentioned herein are purely fictional and have been created solely for training purposes. Any resemblance to existing situations, persons or fictional characters is coincidental. The information presented should not be used as the basis for any specific investment advice. The Guardian Life Insurance Company of America, its subsidiaries, agents, and employees do not give tax, legal, or accounting advice. You should consult their own tax, legal, or accounting advisors regarding their individual situations.

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