Is that a provocative title or what?
Recently, our team participated in a webinar with the top IRA expert in the country, Ed Slott. Ed has written numerous books you can buy from Amazon and has been highlighted on PBS. The titles of his recent books talk about the Coming Tax Time Bomb! One of the things that Ed talked about in the webinar is that the traditional 401k, 403b, IRA, and TSP pre-tax accounts we all have been told over the last 40 years to max out are now some of the worst wealth transfer accounts we can pass on to our kids and grandkids based on tax laws. I thought it was a provocative title, and I picked up his latest book. Passing on these accounts was not always that way. However, in 2019, Congress passed the SECURE Act, drastically changing pre-tax account rules and laws. I will use Individual Retirement Account (IRA) for the rest of this article. However, remember that this applies to other pre-tax accounts like 401k, 403b, 457, and TSP, all variations of employer-sponsored pre-tax accounts.
Ed’s latest book, published in 2024, The Retirement Savings Time Bomb Ticks Louder, highlighted our federal government’s endless need for money. We have discussed the past, the national deficit standing at $34 trillion and consistently rising. Essentially, our Federal Government has already spent money that we will eventually need to pay for. Ed highlights the legislative risk we all are subject to, much like Charlie Brown and Lucy. Congress can move the football. They can make rules one day that seem to our benefit and then change them.
One of the most prominent provisions of the SECURE Act is changing the rules when non-spouses inherit IRAs. The reason we use a term like non-spouse is that when husbands and wives inherit IRAs from one another, they essentially become the survivors and follow the standard IRA rules. Essentially, if a spouse inherits an IRA from another one, they are not obligated to take money out of the IRA until they are 73, and at that time, they have to do Required Minimum Distributions (RMDs). For non-spouses, which means kids, grandkids, siblings, parents, nieces, nephews, friends, etc., the SECURE Act changed from the stretch IRA to the 10-year rule.
If a non-spouse passed away in 2019 or before, the beneficiary could stretch out the tax liability over their life expectancy. Therefore, if a 30-year-old child inherits Mom or Dad’s IRA in 2019 or before, their life expectancy, based on the actuarial table, would be approximately 40 to 50 years. They would be able to spread the tax liability over that period. They could stretch the tax liability over time by taking small withdrawals. The SECURE Act changed that so that the same child would have to liquidate the IRA within ten years after the passing of their parent. Say if someone’s parent passed away this year in 2024, the child would have to liquidate the IRA by 12/31/2035. By changing the law, Congress is accelerating the process of getting money out of IRAs and spending it to the government.
What is one to do? Matt and Paul used to coach me and told me we must adapt to where the legislation goes. Adaptability is one of our core values. Some things you may want to consider:
- If you have a substantial amount already in pre-tax IRA accounts, some of the things we are discussing:
- You may want to consider Roth IRA conversions, where you are taking money from pre-tax now and paying while income tax rates are lower to avoid taking it out in the future when tax rates may be higher. Our team uses Artificial Intelligence software to run analysis. We plan tax management for our wealth management clients if you are interested in this. We believe the goal is not necessarily to reduce your current year taxes but your lifetime taxes.
- If you are still working and contributing to retirement accounts, you may want to consider not building up more and using the Roth feature. Most retirement plans now allow a Roth feature. You are losing the tax deferral you used to have but are not continuing to build up more pre-tax.
- Save for more in post-tax accounts, particularly stocks. We are educating many of our clients that you can invest outside of retirement accounts in post-tax accounts. Because of favorable rules with capital gains, investing in stocks may be beneficial. Additionally, because of step-up rules, post-tax accounts currently have favorable tax considerations when the kids and grandkids inherit them.
- Consider more permanent life insurance within your legacy/estate planning and retirement income.
- We have been giving many of our clients the book The Power of Zero, written by David McKnight. In it, he discusses Life Insurance Retirement Plans, or LIRPs. These are vehicles where one can build up substantial cash value inside a policy during one's lifetime and receive income tax-free when one reaches retirement.
- Life insurance is one of the best asset transfer assets for heirs. The nature of it is that when paid out it is free from income tax or tax free. It also can be structured so that it is left outside of the estate and exempt from estate and inheritance taxes.
- Charitable planning – If charitable giving is an essential part of your legacy planning, consider these:
- You may want to consider leaving pre-tax accounts to charities as beneficiaries and post-tax and tax-advantaged Roth and life insurance to your heirs. Charities will not have the taxes that individuals have.
- This is more advanced planning, where you consider charitable trusts. It should be done in a team with your wealth planner, accountant, and attorney.
The world has changed, and laws have changed. We have to adapt to the constant legislative risk that is out there. At one time, pre-tax accounts were a great way to pass on wealth. Because of the SECURE Act, they are no longer as beneficial as they once were. If you need to talk, let us know.