The SECURE Act has changed the way that advisors will have to talk about taxes with IRA and qualified plan beneficiaries. Before, these beneficiaries had their whole lives to remove that money. Now, they have to do it 10 years, and those more concentrated distributions from IRAs and other qualified plans could throw them into higher tax brackets.
The new 10-year max payout period means financial advisors need to be marking their estate planning files to make sure these “10-year beneficiaries” are receiving the proper tax advice.
The law does not apply to surviving spouses and certain other types of beneficiaries.
The new law means that estate planning attorneys, CPAs, trustees and other financial advisors need to be on alert and giving the proper tax advice after the IRA participant/owner passes. The client’s estate planning file—especially his or her home or safekeeping file—needs to be carefully flagged with a bold notation for the beneficiaries to seek the advice of a competent tax advisor before they make any decisions about the withdrawal of funds from IRAs and qualified plans after the participant/owner’s passing.
Let’s assume, for example, that the participant/owner dies when his or her three children range in age from 55 to 63. Under this likely common scenario, how should the children be advised if they would like to minimize the otherwise harsh effects of the SECURE Act?
The key factor will be tax brackets. Assume, for example, that the 63-year-old child tells you that she is two years from retirement. It’s very likely, then, that it will be wise for this child to defer taking any distribution for two years when the child is still making income (and when extra income from an IRA can pump up the child’s tax bracket). After retirement, the now-65-year-old would take one-eighth of the IRA’s distribution per year.
Now let’s take the 55-year-old. Assume that this child tells you he or she is “about 10 years” from retirement. It’s very likely then, that it will make sense for this child to the spread the IRA proceeds equally over the entire 10-year period.
If a child is not yet on Social Security or Medicare, it may make sense to accelerate the payments. That way, a lesser amount of the child’s future Social Security payments will be taxed (in some states, those benefits can be taxed at the state level as well). Also, the smaller payments will have less effect on future Part B Medicare premiums, in other words, it won’t push them up. Bear in mind, however, that for Medicare Part B purposes there is a “two-year lag” in the reported income figures that the government uses for these computations.
If a child has children of his own who may be in their early working years (and not subject to the so-called Kiddie Tax), it may make sense for the child to disclaim all or a portion of the IRA proceeds so that they will then be spread among more taxpayers—taxpayers who are likely to be in lower income tax brackets than the child who would otherwise receive the proceeds.
The postmortem planning point eventually becomes self-evident: With the advent of the new accelerated distribution rules for IRAs and other qualified plans, the beneficiaries need to shrewdly examine all of their options for withdrawing the proceeds if they want to minimize the family’s overall income tax liability.
James G. Blase is principal of Blase & Associates LLC. He has authored over 50 peer review articles in the estate and tax planning area and teaches a course in Income Taxation of Trusts and Estates in the Villanova University Charles Widger School of Law Graduate Tax Program.