Taxpayers with the largest IRAs (and their beneficiaries) will be in higher tax brackets in the future, meaning that as their tax-deferred traditional IRAs continue to grow, so will the tax bill that eventually comes due. Doing nothing and allowing those amounts grow without tackling this problem is a bad plan.

The big changes wrought by the SECURE Act, specifically the 10-year rule affecting the rate at which people will have to unwind retirement assets in the future, should serve as a giant wake-up call, and a reminder that they should have been doing long-term thinking all along.

Reversing Course
The upshot is that advisors and their clients are going to have to make dramatic changes in their planning and embrace the idea that people with high incomes or ample assets—as well as those likely to be there in the future—should stop contributing to pretax 401(k)s and IRAs.

What’s behind this reversal in traditional thinking about retirement tax planning? For starters, there’s the realization that the tax deductions offered by such accounts are merely loans from the government that will have to be paid back at the worst possible time: in retirement. Worse yet, the payback may come from the accounts’ beneficiaries, who in their peak earning years—and thus peak tax bracket years—could have to pay on the taxable retirement money they’ve inherited from their parents.

Though these inheritance issues have always existed, the original SECURE Act in 2019 managed to further change the game, forcing beneficiaries to take all the inherited retirement account money in 10 years. Previously, they could stretch the distributions over their entire lives, allowing the power of compounding to work its magic and potentially building up enormous account balances over multiple decades. But under the SECURE Act (and the regulations that followed), most non-spouse beneficiaries of retirement accounts must take total distributions within a decade. That 10-year rule shortens the window for complete depletion of all retirement funds. The shorter the window, the larger the required withdrawals—and the higher the resulting tax bracket.

Preferred Path
In the past, we’ve used a “minimum” mentality and let required minimum distributions, or RMDs, drive our tax planning. Instead, we need to think maximum: How much can be withdrawn now, and in the near future, at relatively modest tax rates? It’s tax planning that should be driving our retirement account distributions. Even though the RMD age has been raised to 73, doing nothing until age 73 is a mistake. That may result in more wealth generating inside traditional IRAs, which must be distributed by account owners and beneficiaries. Those distributions probably will be highly taxed, especially for people with large IRAs.

So the best thing is to not let RMDs drive your tax planning. If we take a maximalist outlook instead, the 10-year rule doesn’t matter, and it can be ignored. RMDs don’t matter, so ignore them.

Let’s think instead about “un-required distributions,” and start trimming our IRA and other retirement account balances now in order to use today’s historically low tax rates. That lets clients take full advantage of the current 12%, 22%, and 24% brackets while they are available.

What’s more, recent inflation has raised the income levels for these rates. In 2024, a 24% tax rate applies in incomes up to $191,950 for single filers (an increase from $182,100 the year before) after deductions. After that, a 32% rate takes effect (the 2024 amount for the 24% rate is $383,900 for married couples filing jointly).

Action Plans
This is a moment for savvy tax planning, including taking pretax distributions from retirement accounts this year, up to the taxable income amounts mentioned. Assuming the net cash flow is not needed for living expenses, what might be done with the excess funds?

Roth IRA conversions: Although there are income limits for those who want to make Roth IRA contributions, there are no limits for those making Roth IRA conversions. The latter generally are more effective if non-IRA funds are used to pay the tax. That will mean more money in the Roth account, where qualified distributions are tax-free after five years and after the taxpayer has reached age 59½.

Moreover, after-tax amounts in a Roth IRA can be withdrawn, untaxed, at any time. Consequently, taxpayers holding ample Roth IRAs have enormous flexibility in tax planning. For example, since tax-free Roth IRA withdrawals are not taxed as income, they can be used to keep future income down for those who want to avoid steep Medicare premiums.

The tax-free treatment of Roth IRA distributions also applies to inherited Roth IRAs, so beneficiaries will not owe tax on distributions even if general tax rates climb in the future. However, those who inherit traditional IRAs can’t convert them into Roths later. For estate planning purposes, Roth IRA conversions at modest tax rates can make sense for people at any age, passing the opportunity for untaxed distributions to future generations.

Life insurance: Taxpayers age 59½ or older may want to use the net proceeds from pretax retirement account withdrawals to purchase insurance on their own lives, payable to descendants. The tax benefits of life insurance are exceptional. One is that payouts to beneficiaries usually avoid tax, regardless of the recipient’s income.

In addition, permanent life policies (typically a version of whole life, universal life, or variable life) often include a cash value account. Any investment income within the cash value will avoid tax; the cash value can also be tapped by the policy owner, tax-free, via prudent withdrawals and policy loans.

It’s true that premiums for permanent life insurance tend to be much higher than they are for term life coverage. That said, if workers and their spouses are not contributing to pretax IRAs and employer plans, as recommended here, their after-tax dollars might go into permanent life policies.

Charitable donations: Those taxpayers who have already reached age 70½ or are older should plan on making their charitable contributions directly from their IRAs via qualified charitable distributions (QCDs). These donations count as RMDs but not as taxable income, so they allow IRA owners to reduce their tax-deferred balances without paying tax. That way, appreciated assets in taxable accounts can remain there, without being donated, and eventually pass to heirs with a tax-favored step-up in basis.

Young or old, people with philanthropic intent should cancel all bequests of non-retirement assets to charity; instead, favored causes can be named as IRA beneficiaries. The money can be removed from the decedent’s IRA with no tax for the beneficiary.

Yet another tactic to consider is to name a charitable remainder trust (CRT) as IRA beneficiary. Again, money flowing to charitable beneficiaries won’t be subject to income tax. What’s more, the value of the trust’s assets expected to pass to charity is excluded from estate tax, which might be a major attraction since the estate tax exemption is scheduled to decline in the future with the sunset of a 2017 tax law. (Life insurance may serve to make up for IRA funds lost to loved ones because of the charitable remainder trust bequest.)

Trust Tactics
While we’re on the subject of trusts, remember also that it may not be a good idea to name a trust as beneficiary of a traditional IRA. Under current law, the top 37% tax rate kicks in when 2024 trust taxable income exceeds only $15,200! The required minimum distributions alone on larger IRAs may easily exceed $15,200 and can be taxed at that rate if income is retained in the trust, which may be the case for a discretionary trust that is the IRA beneficiary.

It's true that a well-crafted trust could provide control over a large inherited IRA if there are concerns about how a loved one will handle the inheritance. Such control can reduce the risks of a family member or another inheritor overspending, putting too much overconfidence in a con artist, enduring a costly divorce, etc.

Again, the solution here is to convert traditional IRA dollars to the Roth side via a conversion. A Roth IRA makes a better trust beneficiary because distributions from an inherited Roth IRA to the trust will be income-tax-free, even if the funds are retained in the trust. Roth IRA funds left to a trust remove the trust tax problem for inherited funds that the trust retains.

Taking all these steps can result in larger legacies with less (or no) tax due. Again, we should think maximum, not minimum, and let long-term tax planning drive our distribution planning to control tax rates today, tomorrow, and in the years to come.

Ed Slott, CPA, is the founder of www.irahelp.com. This article was excerpted from the September 2024 issue of his IRA Advisor newsletter.