Prior to December 20, 2019, a very common retirement spend-down/wealth transfer method was to defer and minimize distributions (called a Stretch IRA) from qualified plans (IRAs, including Roth IRAs, 401(k), profit sharing and 403(b) programs) as a way to pass those plans to heirs for generations to come. While beneficiaries would need to take Required Minimum Distributions (RMDs), they could do so over their lifetimes, continue to defer taxes and then pass what was left to their heirs. This strategy has become much less advantageous with the passage and implementation of the SECURE ACT.

While the SECURE Act does allow owners of qualified plans to defer their RMD payments until age 72, beneficiaries who inherit these plans now must distribute the funds within 10 years of the original owner’s death and pay Federal and State taxes along the way.

Beneficiaries who inherited qualified funds from someone who died prior to 2020 will continue under the old rules. Additionally, there are some caveats to the SECURE Act’s 10-year force-out, the goal of which is accelerate tax revenues to the Federal Government. They include:

1. Surviving spouses have the same options as before, including completing a spousal rollover.
2. Beneficiaries who are less than 10 years younger than the IRA owner (e.g., siblings) may use a lifetime Stretch.
3. Disabled or chronically ill beneficiaries may use a lifetime Stretch.
4. Minor children (but not grandchildren) of the IRA owner may delay the 10-year force-out period until reaching the age of majority (age 18 in most states).

How may these changes impact one’s retirement income spend-down strategy? Most people hold their retirement assets in tax-deferred qualified accounts (examples above) and/or taxable accounts. A general rule of thumb holds that liquidating tax-deferred monies first (after age 59½ to avoid 10% early withdrawal penalties) makes sense since 100% of withdrawals will be subject to income taxes (except Roth IRAs). Why? It’s likely that taxes only have one way to go over time and that’s up. The changes in the Stretch IRA rules, discussed above, are a case in point. Also, a glimpse at the U.S. Debt Clock tells the story; the United States is hopelessly in debt.

Under the current tax structure, the next bite at the retirement income apple would be taking money from one’s taxable accounts. On these funds only gains are taxed, presently at a lower rate (California being an exception where capital gains are taxed as income).

A third type of account, discussed in my January 23rd Blog Post are tax-advantaged accounts or “private reserves”. A strategy for those who do not need their qualified funds for near-term living expenses, may want to consider converting these monies, over a 5-10 year period (and after age 59½ to avoid the 10% withdrawal penalty), into a private reserve strategy funded by a permanent life insurance policy. Yes, one would pay current income taxes on qualified funds transferred to the private reserve, but as discussed above, tax rates are likely to go up, not down. This permanent life insurance alternative provides enhanced flexibility, income-tax-free distribution potential and maximum prospective wealth preservation for beneficiaries who are in a higher income tax bracket relative to the IRA owner, as well as potential additional wealth-transfer benefits.

Contact us today to discuss your wealth creation and retirement income spend-down strategy, at (805) 635-7200 or [email protected].

This Blog provides general information that should not be construed as specific investment, tax or legal advice nor the law of any particular state. You should seek the advice of a qualified tax or legal professional for your specific situation.