Have you ever wondered why your attorney recommended language for naming the beneficiaries of your retirement plans and then followed up to make sure you followed their advice? Retirement assets are a significant portion of many of our clients’ assets and are a powerful tool for leaving money to children. Under current law the beneficiaries of a retirement plan have tax advantaged distributions and the retirement plan is asset protected (exempt from the claims of creditors). However, this is all changing. A 2014 Supreme Court case eroded the asset protection of “inherited” IRAs leaving your child’s inheritance subject to creditor’s claims [Clark vs. Rameker, No. 13-299 (U.S. 6/12/14)]. And in September of 2016, the Senate Committee on Finance unanimously voted to approve the “Retirement Enhancement and Savings Act” (“RESA”). This new law would require beneficiaries of an inherited IRA to pay all taxes due on the IRA within five years of the IRA owner’s death, effectively eliminating the “stretch” currently afforded non-spouse beneficiaries of IRAs.
This change in the law mandates that some strategic decisions need to be made by IRA, traditional and Roth, 401(K)s, 403(b)s, simplified employee pensions and qualified retirement annuity account owners in order to take advantage of the stretch-out benefits that are still applicable. For clients with retirement accounts $450,000 or less, the basic “stretch” is still available and may not require additional planning. However, clients with retirement accounts over $450,000 will require strategic planning, such as Roth conversions, lifetime IRA withdrawals to fund (after income tax) irrevocable trusts or the creation of a Retirement Savings Trust© to protect large IRAs from their children’s creditors or divorces.
Let’s take an example.
If Bob dies and leaves a $2 million IRA to his daughter, Susie, she can claim the exclusion and stretch and defer taxes on $450,000 of the IRA over her lifetime consistent with existing law. She must, however, withdraw the remaining $1.55 million within five years, subjecting the $1.55 million of her inheritance to accelerated income taxes, and depending upon her tax bracket as much as 40% tax due in the first 5 years! If Bob has more than one IRA or retirement account, Susie cannot elect which account to apply the exclusion to. She will be permitted to stretch a prorated portion of each IRA account, but, within five years, she must withdraw and pay tax on whatever remains.
Planning for and with retirement assets is going to get much more complicated. Ignoring the planning opportunities that are available with the $450,000 exclusion could be costly to your heirs. If you simply leave everything to your spouse, the family will lose the chance to exclude a portion of the account from accelerated tax. Leaving an IRA to your children outright could cause enormous tax issues for your children. If your children do not manage money well or have creditor or marital problems or other issues, a 5 year payout of a large IRA could be devastating to them. We recommend reviewing your planning and your beneficiary designations in anticipation of these changes. Many of our clients will be eligible for a Retirement Savings Trust which can protect the IRA proceeds and prevent the immediate withdrawal of all of the retirement assets they worked so hard to accumulate. Call our office (512) 263-5400 or email firstname.lastname@example.org today to schedule your complimentary review meeting to evaluate the opportunity to add the Retirement Savings Trust to your planning!
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