The Setting Every Community Up for Retirement Enhancement (SECURE) Act 2.0 was signed into law on Dec. 26, 2022, as part of the Consolidated Appropriations Act, 2023. SECURE Act 2.0 (“Act”) made significant changes to the rules for individual retirement accounts (IRAs) and employer sponsored retirement plans. Most written summaries of the Act focus on the individual changes impacting how Americans fund and take distributions from their retirement plans, but that is only part of the story.
While understanding the Act’s key provisions are important for affluent individuals focused on preserving, protecting and transferring wealth,SECURE Act 2.0has unwelcome aspects that can subject more wealth to estate taxation, strip control from an IRA owner and put a plan’s balance within reach of a beneficiary’s creditors. Cedar Point Financial Services LLC is working with advisors and their clients to determine the impact of the SECURE Act 2.0 andto take the necessary steps to safeguard clients’ legacies.
SECURE Act 2.0 Provisions
The three key provisions in the Act related to retirement plans are:
- The required age to start taking RMDs (required minimum distributions) increases to age 73 this year and to age 75 in 2033.
- The penalty for failing to take an RMD will decrease to 25% of the RMD amount (down from 50% currently) and 10% if corrected in a timely manner for IRAs.
- Catch-up contributions will increase in 2025 for 401(k), 403(b), governmental plans, and IRA account holders. The current IRA catch-up amount is $1,000 but will be indexed for annual increases for those over age 50 and, for those age 60 to 63, the catch-up will be $10,000. For reference, here are current contribution limits and catch-up provisions for common retirement plans:
- IRAs: The contribution limit for Traditional IRAs and Roth IRAs is $6,500 in 2023. The catch-up contribution is $1,000, making the maximum contribution $7,500 this year if the participant is older than 50.
- 401(k) and Other Workplace Retirement Plans: The annual contribution limit for workplace retirement plans like 401(k)s, 403(b)s, most 457s and the government’s Thrift Savings Plan (TSP) stands at $22,500 for 2023. The catch-up contribution amount for these plans is currently $7,500, making the maximum contribution $30,000 in 2023 if the participant is older than 50.
- SIMPLE 401(k): The contribution limit for SIMPLE 401(k) retirement plan accounts is $15,500 in 2023. The catch-up contribution amount is $3,500, making the maximum contribution $19,000 in 2023 if the participant is older than 50.
The obvious intent of SECURE Act 2.0 is noble: it promotes tax-deferred savings by allowing retirement plan participants the ability to save more and to save longer. Participants who do not intend to use part, or any of their retirement plan balance, find the ability to increasingly put off RMDs especially attractive. This means those account balances will likely balloon in size over time and therein lies the problem for wealthy retirement plan owners.
Additional Considerations…..or Challenges
Owning an IRA with a large balance may not be financially prudent for those who will not be relying on IRA distributions for their own retirement income. First, should the IRA owner die unexpectantly, especially after IRA funding has ceased and there is a large account balance, the IRA’s balance will likely be included in a deceased participant’s estate under Internal Revenue Code §2039(a). This section provides that a decedent’s gross estate includes the value of a qualified plan, an annuity, or other payment receivable by any beneficiary by reason of surviving the decedent.
Another challenge for affluent participants who leave their IRA balance untouched is that a larger fully (income) taxable distribution will eventually be forced upon most non-spouse beneficiaries who inherit the IRA, and who will be required to withdraw the full balance within 10 years. These beneficiaries are often adult children and grandchildren who no longer are permitted to stretch the period of distributions over their lifetimes and who will typically incur higher taxation from a shorter, payout period.
Increased taxation is not the only impact of the Act that concerns many. There now exists a loss of control, resulting from taking away a participant’s decision making about when and under what conditions heirs should receive proceeds. Also, forced distributions to beneficiaries can remove a large amount of wealth from creditor protected IRAs and expose it to beneficiaries’ present and future creditor claims, including claims from beneficiaries’ former spouses. This triple hit of a loss of control, increased income and estate taxation, and exposure to creditors is not a welcome result of legislation intended to promote savings!
Fortunately, Cedar Point Financial Services LLC educates clients and their advisors on the steps that can immediately be taken to replace qualified retirement plan and IRA funds that may be lost to taxation while protecting it from creditors, and to reduce a taxable estate while providing the option to potentially benefit a client’s favorite charity.
Since the SECURE Act 2.0 still requires RMDs while accelerating payouts to most non-spouse beneficiaries, those wishing to pass on accumulated retirement funds to children or grandchildren can be left frustrated. The loss of the ability to stretch the distributions of a retirement plan over the lifetime of a grandchild can have a major impact on a financial plan. It may be wise to apply a retirement plan’s balance more tax-efficiently through other planning. One solution is to combine life insurance with a trust.
For example, IRA owners (grantors) can direct their after-tax RMDs into irrevocable trusts and use a combination of annual gift tax and lifetime gift tax exemptions to fund the purchase of life insurance. The grantor’s trust would be the owner and beneficiary of the policy and the intended heirs of the grantor owner would be the beneficiaries of the trust.
When the policy death benefits are distributed to the trust, the proceeds will be income tax-free to the trust and paid out as directed by the trust agreement. In addition to ‘stretching’ out the money from an IRA to the heirs by converting distributions to trust-owned life insurance, the proceeds would not be subject to estate taxes.
Another benefit of establishing an irrevocable trust that will ultimately be funded with life insurance policy proceeds is that both the policy and the resulting lump sum policy death benefit proceeds will be held by the trust and not the trust’s beneficiaries, and therefore, not subject to the creditors of those beneficiaries. The trust can be arranged so that the amount and timing of distributions to beneficiaries can either be established in the trust documents or left to the discretion of the trustee. This arrangement provides more security(asset protection) for wealth marked for generational transfer over the payout requirements for an inherited IRA.
Carrying Out Charitable Wishes
While it may be ideal to exhaust an IRA’s account balance while living and purchase life insurance in an irrevocable trust, it may be prudent to leave some funds in an IRA. Once a strategy for wealth replacement and wealth protection is in place, switching an IRA’s beneficiary to a tax-exempt charity can also produce some benefits.
First, the charitable gift could reduce estate taxes or provide other tax relief. Then, of equal importance to many, a favored community organization would be supported. This gift can even be equalized to beneficiaries by increasing the amount of death benefit purchased in the trust. The planning specialists at Cedar Point Financial Services LLC have decades of experience incorporating charitable giving into tax-efficient wealth transfer strategies.
Help is Here to be Secure
This blog covers only some of the changes made by SECURE Act 2.0. Advisors should create a simple list of the changes, including effective dates, and determine which ones affect clients. This list can be used to help identify which clients should be contacted regarding changes.
As described, there are several planning steps to carry out a strategy that ensures clients are not at a disadvantage due to SECURE Act 2.0 and plan accordingly. Cedar Point Financial Services LLC can support clients’ advisors by serving as a knowledgeable resource and a valuable part of a planning team.