Ed Slott’s recent articles in response to the SECURE Act, while well-intended, contain too many overgeneralizations regarding estate planning. Let’s take his February 6, 2020 online article in Financial Planning, for example: “Why Life Insurance Is The New Stretch IRA.”
The article’s initial premise is certainly correct: “Clients [with the largest IRA balances] are naturally concerned about post-death control. They built large IRAs and want to make sure that these funds are not misused, lost or squandered by beneficiaries due to mismanagement, lawsuits, divorce, bankruptcy or by falling prey to financial scams or predators.” Unfortunately, it is from this point on that the article reverts to making several overgeneralizations regarding estate planning with IRAs, and the use of trusts.
In the first place, life insurance is not the new stretch IRA. Life insurance has always played an important role in tax and estate planning for IRAs, but it is not the “new stretch IRA.” We should not be misleading clients into thinking it is.
The article suggests: “In order to keep your client’s IRA estate plan intact, the IRA portion will probably have to be replaced with either a Roth IRA (via lifetime Roth conversions) or with life insurance, which offers better leverage and flexibility since it won’t be subject to any post-death Secure Act limitations.” “Replaced?” So the goal is to completely replace (i.e., with life insurance or Roth IRAs) the IRA portion of the estates of clients “with the largest IRA balances?”
Although it is definitely recommended that clients consider annually “milking out” a portion of the IRA at lower income tax rates (e.g., after the client has retired) and rolling the after-tax proceeds into life insurance and/or, in the case of the portion of the withdrawal over the required minimum distribution for the year, a Roth IRA, the advisor must be very careful before embarking on a program to completely replace "the largest IRA balances" among our clients in this fashion, without first carefully examining the after-tax math associated with each individual plan.
The article also suggests cashing out IRAs, paying income taxes, now, at potentially significant income tax rates, and then using the after-tax proceeds to purchase life insurance for grandchildren. Remember that these same grandchildren are likely to be in lower income tax brackets than their grandparents at the time of the liquidation of the taxable IRAs. If we are going to use the after-tax IRA proceeds to purchase tax-free life insurance (which, again, can be an effective tax-saving strategy), then why do we need to leave the life insurance proceeds to grandchildren, when we were only using them for their longer life expectancies (which now have become moot), in the first place?
If we are primarily using grandchildren for the income tax leverage that they bring to the table, why don’t the same grandchildren bring income tax leverage for IRAs after the SECURE Act? Remember, these grandchildren are likely to be in lower income tax brackets than the IRA owners doing the liquidating of the largest IRA balances, and, more importantly, are likely to be more numerous than one IRA owner, thus spreading the taxable IRA proceeds over more taxpayers.
The article continues:
“Under the old stretch IRA rules, if the trust qualified as a see-through trust, RMDs could be based on the age of the oldest grandchild, say, a 19-year-old. RMDs would be paid to the trust and from the trust right through to the individual grandchildren over 64 years (the life expectancy for a 19-year-old), leaving the bulk of the inherited IRA funds protected in trust for decades…”