How to Beat the SECURE Act

A few weeks ago, I caught a local financial advisor giving a short talk about how he helped a recent client. The client was in their mid-70s. She had reached a point in her life when she had all the money she needed and wanted to plan how best to give it to the kids.

She was at the point where she had to take RMDs from her retirement plans. However, her income outside of that was low without a standard job. That was fine; she didn’t have a lot of expenses. She had paid off her mortgage. She lived frugally. She had a lower income, which meant that she was taxed very little.

The financial advisor noted that her kids were in their prime earning years. He didn’t go into specifics, but I’m guessing they were already in the 24% rate. Due to the recent SECURE Act, if she died, the kids would have to withdraw the money over ten years and pay their tax rate on it. Before the SECURE Act, the heirs could take the money out over a long time. This was known as a Stretch IRA. It would be easier to stay in a lower tax bracket and take a little money each year. With the SECURE Act’s 10-year rule, some heirs could be taxed on much of the money in the 32% tax bracket.

What’s the point of saving for retirement and all the rules that come with it if you don’t get to use the money and your heirs are still going to pay 32% in taxes?

The financial advisor then said something that I won’t soon forget. In 21 years of advising people, no one has ever come in saying that they’d love to give money to the IRS. This fits in the category of having a “good problem .” I usually say that I don’t mind paying taxes because it means that I made a lot of money. Nonetheless, one way to make our money work smarter is to pay few taxes when it’s legal.

You’re probably familiar with many personal finance blogs if you’re reading this. It’s also likely you’ve made most of the “right” money moves, such as saving a lot for retirement. There’s a chance you’ll find yourself in a similar situation as this client. Decades of compound interest add up.

I’m 46 now, but I could see this situation happening to us in 30 years. Using a quick rule of 72, our savings could quadruple. We’ll probably live off my wife’s pension, side hustles, and rental property income. I know a lot can (and likely will) change with laws, but I find it’s best to plan for the current laws and adjust later. That means planning to beat the SECURE Act’s 10-Year Inherited IRA Rule.

What is the SECURE Act?

The SECURE Act (Setting Every Community Up for Retirement Enhancement Act) is a law that was enacted in the United States in December 2019. (I had hoped to write about it then, but something happened in March of 2020 that distracted me. I can’t quite remember what it was, but I think it rhymes with SOVID.) The SECuRE Act aims to improve retirement security for Americans by making it easier for them to save for retirement and by providing new options for how they can use those savings.

Some of the key points of the SECURE Act include the following:

• Increasing the required minimum distribution (RMD) age from 70 1/2 to 72 for retirement account holders.
• Allowing individuals to continue contributing to their traditional Individual Retirement Accounts (IRAs) after they reach the age of 70 1/2.
• Providing a new option for annuity contracts within 401(k) plans, allowing workers to receive guaranteed income in retirement.
• Making it easier for employers to offer student loan repayment assistance as a workplace benefit.
• Requiring beneficiaries of inherited IRAs to be distributed over ten years. (The “10-Year Rule”)
• Allowing long-term, part-time workers to participate in 401(k) plans.
• Encouraging small businesses to offer retirement plans to their employees by providing them with tax credits and other incentives.
• Providing a new tax credit for small businesses that offer automatic enrollment in their retirement plans.

How to Beat the SECURE Act

Let’s get back to the financial advisor and his client. Here are some ways to beat the SECURE Act’s 10-Year Rule:

1. Give the Money to Heirs Early

I thought the financial advisor was going to suggest that she take significant money out of her IRA and gift her potential heirs up to $16,000 annually. (It will be $17,000 in 2023.) This way, she’d only pay tax on what she takes out. Since she’s not earning an income anymore, we assume this would be at a much lower tax rate. Perhaps she can use her standard deduction, and the effective tax rate could be close to 18%. The heirs wouldn’t need to pay any further taxes on the money.

The downside to this approach is that his client wouldn’t control the money anymore. That may be okay for some people, but it could be concerning to others. Also, giving away $16,000 a year could take some time, depending on how much money you have and how many heirs you have.

2. Invest the money in a Regular Brokerage Account

She could take some money from the IRA each year and invest it in a regular brokerage account. When she dies, this money will go to the heirs on a stepped-up cost basis. That means heirs wouldn’t need to pay tax on all it has gained over time.

The advantage of this approach is that she keeps control of the money.

Let me take you through an example of how I think this could work.

We’re going to have to make some assumptions for the example. First, we’ve assumed that she’s single (widowed, I think) and not filing jointly. Let’s also assume she needs around $40,000 to live on. She’s paid off the house but still has property taxes, and inflation is high.

Scenario A: She can take out about $85,000 in her IRA and stay at the 22% bracket. She’ll spend the first $40,000 and put $40,000 in a brokerage account – she’ll use the remaining $5,000 to help pay the 22% taxes. (I know the $5,000 isn’t a lot to pay the taxes, but she has standard deduction and other credits, so it mostly works.)

The $40,000 in the brokerage account continues to grow. She contributes this $40,000 every year, and in ten years, she’s put $400,000 in there, but with compound interest, it is around $600,000. Let’s say she dies in her mid-80s. (I’m not trying to bring you down, but this shouldn’t come as a surprise. It wasn’t going to end with her discovering the Fountain of Eternal Youth.) The heirs get the $600,000 on a stepped-up basis. It’s regular inherited stock, so there is no SECURE Act IRA 10-Year Rule.

2b. Backdoor Roth IRA

She could take the money from her IRA and put it in a Roth IRA, paying taxes. This is very similar to the above plan, so I labeled this as 2b. I need to explore more about backdoor Roths before I can write knowledgeably on the topic. Fortunately, there are a lot of resources out there.

3. Buy Life Insurance

The advisor mentioned that the client could also buy life insurance. Of course not all people in their mid-70s will be eligible. However, she could use that money to buy a lot of life insurance that would then pass to the heirs tax-free. I’m not great with life insurance, so I have no idea if this works in practice, but it is an intriguing concept I never thought of. At her age, it may make sense. That’s why she has a financial advisor. At my age, I don’t want to buy life insurance to beat the SECURE Act. I’m always worried that there are significant expenses from the insurance agent.

5. Other Alternatives

The client can also donate money to charity, but that doesn’t pass the money onto her heirs. I would say that’s a supplemental tax strategy.

The client can also purchase a qualified longevity annuity contract (QLAC). This is another area where a financial advisor is probably a great idea. You can avoid paying some RMDs and put the money towards an annuity that kicks in later in life (usually around 85). This could give the client some security, knowing that she won’t outlive her money if she lives to 100 or more. Again, this is a supplemental tax strategy and not a way to beat the SECURE Act, as it doesn’t pass the money to heirs.

Another option is to use a charitable remainder trust (CRT). With a CRT, you can transfer assets from a retirement account to the trust, and the trust will make annual payments to a charitable organization. When the trust is terminated, the remaining assets will be distributed to your beneficiaries. This can help reduce the tax burden on your heirs and provide a charitable deduction for you.

What About SECURE Act 2.0?

A few hours before publishing this, the SECURE Act 2.0 was included in the year-end spending legislation. It’s an update to the original SECURE Act of 2019. I think it’s very likely that the President will sign this into law.

There’s a lot in the SECURE Act 2.0, but it seems that much of it applies to particular situations. The big change that would apply to everyone is pushing back the RMD age to 75. I’m not sure if that’s a big win for us. On one hand, we can let our money grow more. On the other hand, we’ll presumably have this larger amount to take out at age 75. Taking out a larger amount at regular income tax rates could be much higher than qualified dividends or long-term capital gains.

Another possibility is to use a trust to hold the assets from the retirement account. By transferring the assets to a trust, you can specify the terms under which the assets will be distributed to your beneficiaries. This can allow you to control the timing and amount of distributions, potentially reducing the tax burden on your beneficiaries.

Final Thoughts on Beating the SECURE Act

As you may have gathered from this article, these are complicated topics. You might need a financial advisor, tax specialist, and/or estate planning attorney to do them right.

As much as I love making my own money choices, this is one area where I’m happy to pay for the expertise of professionals.