How The Secure Act Has Modified Legacy Planning - and how do you stop your heirs from losing out?
Tuesday, July 21, 2020
By David Schlossberg, Tax Plan for Wealth, Inc
Under the prior rules, before the Secure Act existed, was the stretch IRA and stretch Roth IRA. It was a wonderful world where IRAs inherited by younger generations could enjoy tax advantaged growth for the lifetime of your heir. 

Depending on the heirs age at inheritance, a minimum amount needed to be distributed each year and the remainder could retain the tax beneficial growth. 
IRA assets (including Roth IRA assets throughout this discussion) that are inherited are generally protected assets in most states. 

That usually meant that if your child inherited your IRA assets and was sued for any reason, the funds retained in the IRAs and not distributed would typically be protected from that lawsuit₁. This also applied to family related lawsuits such as a divorce action. 

Retained IRA assets inherited by your child would typically not be deemed a marital asset subject to division. In other words – your future ex-in-law isn’t entitled, and it would be preserved for your child.

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:
Consult legal advice for specific rules in your state
Several exceptions to the ten-year rule do apply. 
This represents a hypothetical worst-case scenario where income taxes on the conversion come from the Roth post conversion. Most planning done by Tax Plan for Wealth would use other assets to pay Roth conversion income taxes with the hopeful outcome that the entire $1,000,000 is in the Roth account.
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Tax Advisory Services offered through The Tax Plan for Wealth, Inc. Tax Plan For Wealth, Inc does not provide investment advice. Should you request information about services including financial planning or investment advisory, those services may be referred to as an affiliated business. Please refer to https://www.assuredgroup.com/ for more information. We always suggest you seek professional advice. Past performance is not a guarantee of future results. Investing involves risk including loss of principal. The information provided is not directed at any investor or category of investors and is provided solely as general information about products and services or to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither National Securities nor its affiliates are undertaking to provide you with investment advice or recommendations of any kind. Every family's set of details bring a unique outcome, therefore these opinions should not be relied on for your unique circumstances.
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