Mitigating the Impact of the SECURE ACT
The SECURE Act has introduced significant changes to the distribution rules for individual retirement accounts (IRAs) and Internal Revenue Code Section 401(k) plans, including 401(a), 403(b), and similar retirement accounts, following the account holder’s death. Specifically, the law imposes a mandatory 10-year distribution period, which often coincides with the children’s peak earning years. As a result, any distributions from these retirement accounts are likely to be taxed at higher income tax brackets. However, a strategy involving a charitable remainder trust (CRT) offers account holders an opportunity to minimize the tax impact while providing for their heirs. By utilizing a CRT, the income from an IRA or 401(k) can be spread out over a longer period, effectively reducing taxable income during those high-earning years.
Previously, due to historically low interest rates, a CRT strategy did not offer substantial benefits to beneficiaries. However, with current interest rates, the strategy has regained its effectiveness. For example, a permissible 7.2% annuity rate paired with the April 2023 Section 7520 rate of 5% would result in the children receiving 144% of the trust corpus. Additionally, half of these payments could occur between years 11 and 20, likely when the children are retired and in lower tax brackets. Furthermore, the SECURE Act 2.0 allows heirs to delay taking their own IRA distributions until age 75, which could coincide with the lowest tax bracket years of their lifetime.
Consider a scenario where the youngest child is 55 years old at the time of the account holder’s passing and plans to retire at 65. In this case, the maximum annuity payments from the CRT would be distributed over 20 years, with reduced amounts during the child’s working years and larger payments during retirement, which would likely be taxed at a lower rate. This benefit is enhanced by SECURE Act 2.0, which extends the child’s required minimum distribution start date to age 75. After the 20-year distribution period, the remaining trust assets are transferred to a designated charity, supporting causes important to your family. This can be done directly or through a Donor Advised Fund for added growth potential, depending on legacy planning goals.
Additionally, there are options to further mitigate the income tax burden on heirs. Typically, distributions from a taxable IRA or 401(k) are subject to federal income tax at the beneficiary’s rate, without any preferential treatment for qualified dividends, long-term capital gains, or tax-exempt income. However, once the CRT has paid out an amount equal to the initial taxable distribution from the retirement account, subsequent payments may be taxed at a lower rate. By delaying the initial payout for several years, heirs can time their distributions to occur during lower tax periods.
In conclusion, utilizing a CRT to provide annuity payments to heirs can help alleviate some of the tax challenges posed by the SECURE Act. With higher interest rates and extended mandatory distribution periods, this strategy is now more beneficial than ever. By spreading distributions over a longer timeframe, heirs can potentially receive income at lower tax rates, helping to reduce the overall tax burden while still supporting charitable causes important to your family.
If you have questions, would like to discuss this strategy or other tax mitigation strategies, your particular financial or investment situation, please contact a Waverly Advisors, LLC professional today.
MEET THE AUTHOR
Steven M. Gronceski, CFP®, AIF®
Partner, Wealth Advisor, Waverly Advisors, LLC
Steve brings 25+ years of experience to Waverly. He is an experienced high-net-worth investment advisor, with a focus on business owners, corporate executives and professionals. As a TIAA authorized advisor, he works closely with clients in the medical and academic professions…. Learn More
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