LEGISLATION
300k
250k
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Tax
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Need
Post-Secure Act from page 40
A common solution for tax-focused advisors is a Roth
conversion. A Roth conversion is essentially paying taxes not to
transfer money from a traditional, pre-tax IRA into a Roth IRA. A
lesser balance in the traditional IRA lowers the eventual RMD from
that account. Advisors who use this technique generally target the
amount of conversion to level out the taxes before and after RMDs
while avoiding situations where a conversion amount would push
the client into higher brackets or create interactions with other
income sources.
Roth IRAs have several characteristics that may be advantageous
for overfunded retirees and their beneficiaries. First, because
the money goes in after tax, all growth is tax free, allowing a
potentially long period of tax-free compounding. Second, there
are no RMDs from Roth accounts during the original account
owner’s lifetime, further increasing compounding. Finally, a
beneficiary can inherit the account free of federal income tax.
Prior to the SECURE Act of 2019, the beneficiary was forced to
take RMDs based on life expectancy, allowing another 20+ years of
potential tax-free growth. The ability to “stretch” a Roth IRA was
truly a powerful planning tool. After the SECURE Act, the account
must be emptied by the 10th year following the account holder’s
death. This is a critical change. Prior to the SECURE Act, Roth
conversions had a substantial advantage over life insurance
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Perspectives
Q2 2020
as a planning tool because although life insurance death benefits
are tax free to the beneficiary, the beneficiary must the invest the
proceeds somewhere, giving rise to the tax on growth that occurs
during the beneficiary’s lifetime, compared to a much longer
period of tax-free growth and withdrawals from the Roth.
With the new 10-year limitation, the benefits of life insurance
are now much closer to the Roth, particularly for clients with
a conservative to moderate risk tolerance. For these clients,
tax-deferred accumulation and tax-free withdrawals to basis
and loans thereafter mimic the benefits of the Roth. A properly
selected and structured life policy is likely to provide a reasonably
similar internal rate of return to that of a mostly bond portfolio,
particularly in rising interest rate environments. A need for
protection against potential long-term care expenses can thus flip
the advantage from the Roth to life insurance.
In the event the beneficiary ends up with a similarly overfunded
situation as the original owner, life insurance proceeds can be
used to pay taxes on conversions of the beneficiary’s own IRA
funds, following the same logic as the original account owner.
Of course, all of this assumes that Roth tax treatment will stay
constant in the future. It is not inconceivable that all beneficiary
deferrals on Roth accounts could be eliminated, particularly
because that elimination would have no direct adverse impact on
the beneficiary, which would further reduce the Roth’s advantage.