Financial Planning Ideas after the SECURE Act
In the Hook Law Center Newsletter dated December 23, 2019, we introduced readers to the SECURE Act, which, among other things, changed the way that beneficiaries of qualified retirement plans are required to withdraw those funds after the participant’s death. In short, except for a limited class of “eligible designated beneficiaries”, such as spouses, minors and the disabled or chronically ill, beneficiaries of qualified retirement plans must withdraw the entire account within ten years of the participant’s death. Now that the lifetime “stretch” for most of our beneficiaries has gone away, what are some alternative financial planning techniques that are available to help families maximize their wealth for future generations?
Before discussing the benefits of converting a qualified retirement plan or traditional IRA to a Roth IRA, it is important to revisit the distinctions between the two. A participant typically contributes to a qualified retirement plan with pre-tax dollars or contributes to a traditional IRA and receives an income tax deduction equal to the amount of the contribution. Additionally, while the funds are invested in the qualified retirement plan or traditional IRA, the tax on interest, dividends, and growth is deferred until the funds are withdrawn during the participant’s retirement years. In exchange for the tax benefits of contributing and the tax deferral during the participant’s working years, the entire amount withdrawn from the plan or IRA is taxed as ordinary income at the time of withdrawal. On the other hand, the owner of a Roth IRA contributes after tax money to it, meaning there is no income tax deduction allowed for the contribution, but all withdrawals from the Roth IRA during retirement are free from income tax.
A financial planning technique that has been around for a while is the Roth Conversion. This is the act of converting a qualified retirement plan or traditional IRA to a Roth IRA. At the time of the conversion, the owner pays ordinary income tax on the amount converted. People typically use this planning technique if they believe that the taxes they will pay on the conversion will be less than the taxes they would have had to pay over their lifetime on required minimum distributions from their qualified retirement plans and traditional IRA’s. Similarly, with the new ten-year rule under the SECURE Act, families can analyze the tax consequences to the family overall and decide whether a Roth conversion or a series of Roth conversions make sense. If the parents will pay less taxes on a Roth conversion than their beneficiaries will pay during the ten years following the last parent’s death, a Roth conversion may make sense.
Life insurance continues to be a tax-advantaged way to leave a legacy. Not only is the death benefit received by the beneficiaries income-tax free, but with the right structure in place, the benefit can be received estate-tax free as well. Whereas, before the SECURE Act, the life-time stretch available to beneficiaries of IRA’s made an IRA a significant legacy tool, now families may want to consider replacing that legacy tool with life insurance. In fact, when the qualified retirement plan or IRA participant does not need the required minimum distributions to meet their lifestyle needs, the RMD can be used to pay the premium on the life insurance policy.
Split Beneficiary Designations between Spouse and Children.
Surviving spouses still get to stretch the qualified retirement plans and IRA’s they inherit over their life expectancy. Therefore, it may be tempting to leave an entire plan or IRA to a surviving spouse. However, if the surviving spouse does not need the money in the retirement account to fund his or her lifestyle, it may be prudent to leave only some of the plan or IRA to the surviving spouse and the rest to the children. The children will need to start withdrawing from the plan or IRA over the ten year period, but when the surviving spouse dies, the children will then begin a new ten-year period.
Ask Kit Kat: Frogs in the Cold
Hook Law Center: Kit Kat, how do frogs survive during cold weather?
Kit Kat: Well, actually, it turns out that some fare quite well in cold weather. Of 4,800 species of frogs, five which are found in North America are able to withstand freezing temperatures. Whether it is their preferred climate is another question, but at least they do not suffer because of it. Naturally, this is the opposite of what one might think for a creature who has no outward covering that is visible for anyone to see. What happens in these freeze-tolerant species is that “Glycogen in their bodies converts to glucose, which helps keep cells from dehydrating. As the chill deepens, organs stop functioning and as much as 70% of the water in their bodies can become frozen—a condition they can survive for months,” according to Joanne Kimberlin of The Virginian-Pilot. Those that don’t have this capability, try to stick out our area’s cold dips by burrowing in the dirt, under leaves, or under mulch in flower beds.
If you are a frog aficionado, you will like living in the Hampton Roads area of Virginia. The Virginia zoo in Norfolk has already sponsored two classes this year as a part of FrogWatch USA. FrogWatch uses trained volunteers to identify differing frog species, mostly by listening to the sounds they make. According to Dennis McNamara, lead reptile keeper at the zoo in Norfolk, most of the noises you hear outside at night aren’t insects or birds. Ninety percent of it is frogs and toads.” Not to worry—there’s another ForgWatch class on March 8, 2020 at the Virginia Beach Aquarium and Marine Science Museum.
Nature never disappoints in its variety and complexity! (Joanne Kimberlin, “A big chill for the frogs,” The Virginian-Pilot, Feb. 15, 2020, p. 1 & 12)