Recent legislation called The SECURE Act (Setting Every Community Up for Retirement Enhancement Act) has widespread effects over many financial plans. One of the more interesting changes made regarding how beneficiaries can inherit retirement monies.
If you are in an unmarried relationship and are planning to remain unmarried there are many details of this new rule that could unknowingly affect you. What I will describe below will affect all non-spouse beneficiaries with only a few exceptions: 1) Individuals less than 10 years younger than you 2) Disabled individuals (as defined under strict IRS Rules) 3) Chronically ill individuals and 4) Minor children (up to age of majority. Does not apply to grandchildren). If any of these scenarios describe you and your partner, then you will not be affected. But if your partner is less than 10 years older than you, or you are not part of any of the other groups listed above, then you have many changes to address in your estate plans.
Let’s first start with the scenario of your partner being older than you by less than 10 years as there are some interesting rules to abide by. The main distinction of what will happen to your partner upon inheriting from a younger non-spouse will depend on whether or not you die before or after you’ve started taking your Required Minimum Distributions (RMDs). For instance, if you are 55 and your partner is 65, you have obviously not started taking RMDs. In this situation, your partner will be able to withdraw using their life expectancy.
But if you were already receiving RMDs, such as you are age 75 and your partner is 77, then your partner will still be able to have payments paid over their lifetime, but they could actually have been better off if you had left the IRA to your estate, and then directed the account your partner through your will (or, better yet, left the account to a trust that intentionally does not qualify as a Direct Beneficiary) as your partner could then have stretched the account withdrawal over your remaining life expectancy, which is longer than their own life expectancy.
How it used to be vs. Now
Generally speaking, it used to be that upon inheriting a retirement account a non-spouse beneficiary would need to start making annual withdrawals on the account based on their life expectancy starting the following year after death. This would stretch the tax burden over their lifespan and hopefully making it less impactful on the beneficiary’s tax bracket.
Many unwed partners used an annuity for their IRA monies as a way to spread the tax burden over their lifetimes as well as ensure lifetime income for each other. In this case one of the partners would own the account and list their non-spouse partner as their joint annuitant. Though this option is still a fantastic option for non-retirement monies, it is not viable for retirement funds due to the 10 year liquidation stipulation that I touch on below. If one of these strategies was put in place prior to the SECURE Act there will likely be issues with this strategy unless there is a cash-out clause or some other modifications available on your plan.
Now, with the SECURE Act, all non-spouse beneficiaries inheriting retirement from those deceased on or after January 1, 2020 will have a total of ten years to clear out the account. So instead of having a mandatory annual withdrawal to make on the account, the funds can remain invested for up to 10 years before the account is required to be fully withdrawn.
As you might imagine, the rules are different for spousal beneficiaries. Upon inheriting a retirement account a spouse can assume the account as their own. Meaning, they can roll it into one of their own retirement accounts and treat it as if it was theirs from the beginning. Depending on the age of the spouse there may or may not be annual withdrawal requirements (called Required Minimum Distributions, or RMDs) to be made immediately. This not only stretches the tax burden over the survivor’s lifespan, but it ensures the survivor will never be forced to empty their account entirely and be destitute as a result.
How this leads to planning opportunities
If you are not married and are considering marrying your partner, then the differences mentioned above might be an additional reason for you to go forward with your plans. But maybe you plan to remain unmarried to each other, perhaps due to ex-spousal benefits or other personal reasons. If this is the case, then you might consider some of the following ideas.
The unfortunate truth is that there really are no loopholes or options available that will ultimately delay paying taxes similar to the way it was done prior to the SECURE Act. But, for the next few years anyway, there is a strategy that may be even better than the old way. Due to the tax modifications made at the end of 2017 you might find yourself in a lower tax bracket than you used to be. If you are part of the group benefit from this then you have until the end of 2025 to take advantage of the rates as they sunset at the end of 2025 and rates will go back to where they were in 2017.
If you find you’re currently in a lower tax bracket than your partner’s future tax bracket (I encourage you to research the old 2017 tax brackets and deductions to use as a guide) then you might consider converting some or all of your pre-tax monies into a Roth IRA. This way, even though the 10 year liquidation rule will still apply, your partner won’t be responsible for paying taxes on the withdrawal. So not only will they not be responsible for paying taxes using their higher tax bracket, but all the gains earned between the time of conversion and the end of the 10 year period will all be tax-free.
Another strategy utilizing the tax breaks is as follows. If your tax bracket now is lower than both your and your partner’s future tax bracket you might consider making withdrawals from your pre-tax retirement account now and paying the taxes using your lower tax bracket. You can then use the proceeds to invest in a joint brokerage account using growth-oriented investments so as to build up long-term capital gains (rather than taxable dividends). This will do two things: 1) Your gains will now be taxed using the preferred tax rates of Capital Gains vs. that of ordinary income 2) Upon your death your partner will get a step-up in basis to the value of the assets on the date of your death. This can be very influential as all the built-up gains in the investment are considered tax-free upon the first owner’s death. The survivor can then sell those investments without having to pay taxes on the old gains.
Lastly, a strategy that isn’t dependent on tax brackets but is perfect for those who are charitably inclined would include life insurance. In this scenario you could purchase a life insurance policy for the equivalent of the retirement account value and list your partner as the beneficiary. At the same time, list the charity as the beneficiary of the retirement monies. You could set it up so you could get a tax deduction now and upon your death the charity will receive the retirement account tax-free and your partner will receive the equivalent tax-free.
The SECURE Act is still very new, and there are still a lot of nuances that need to be clarified in order for us to plan effectively. But so far, with what we already know, there are several ways we can “put lipstick on the pig”, so to speak, in hopes of making the best of an ugly new rule.
Lincoln Financial Advisors Corp. and its representatives do not provide legal or tax advice. You may want to consult a legal or tax advisor regarding any legal or tax information as it relates to your personal circumstances.
Carrie Waters Schmidt is a registered representative of Lincoln Financial Advisors Corp. Securities and investment advisory services offered through Lincoln Financial Advisors Corp., a broker/dealer (member SIPC) and registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies. Equanimity Wealth is not an affiliate of Lincoln Financial Advisors. CRN-2964583-022020