It May Be Useless By the End of the Year Have a Trust?
In May, the House of Representatives overwhelmingly voted in favor of the SECURE Act, with 417 votes to 3. Short for Setting Every Community Up for Retirement Enhancement, the SECURE Act of 2019 still has to go through the Senate, but with bipartisan support, it is likely to pass.
Withdrawing over time can cause problems, as well. Let’s say you’re in the middle of putting your kids through college. If you’re paying for tuition with loans that are based on your income and you withdraw from the IRA, you could change your income status. If it becomes too high, you may lose access to those loans. A lot of people put their IRA into a trust so their beneficiaries don’t have access to it all at once. There’s a saying: The only reason to set up a trust is when you don’t trust someone. You might be worried that your kids or grandkids won’t be able to manage the money. Or, if there is a chance they could be sued, that money would be on the line. Families face countless scenarios that justify using trusts. When you put the IRA money into a trust, it’s protected. Creditors can’t get to it, and the money can be dispersed a little at a time. The downside of putting the money into a trust is the taxation. If left in a trust, the tax rate is very high. In the past, people set up “conduit trusts.” The IRA money passes through the trust to the beneficiaries. However, because most beneficiaries will no longer have RMD’s with this new law, the money would now sit in the trust exposed to the high tax rates in trusts.
While the SECURE Act may have support in Washington, it has also raised a lot of questions among retirees about what to expect.
One minor thing the act changes is the age when you must start taking your required minimum distributions. Right now, it’s at age 70 1/2. Should the act pass, it would be bumped to age 72. The main issue with the act, however, is how it changes IRAs. Currently, if a person doesn’t spend their IRA before they pass away, the remainder usually goes to their kids, grandkids, or other heirs. Through this process, the heirs (nonspousal) could create what’s called a “stretch IRA,” continue to grow the money in the IRA, and withdraw smaller required amounts based on their own birthdate. Ideally, the IRS wants you to deplete your IRA before you pass away. They want your savings spent, not to have them sit there from generation to generation. This is why your RMDs increase once you turn 70 1/2 — they want you to take more as you age. Your heirs don’t have to worry about sizable RMDs. Depending on their age, it’s likely they will take more manageable amounts that are just small enough that the IRA can continue to grow. This process has benefited a lot of families, but the SECURE Act aims to change this. Last month, I told you your IRA was under attack, and the SECURE Act represents another reason why an IRA is the worst type of account to put your money into. If the SECURE Act passes in the Senate, IRAs will be even worse. Your beneficiaries will no longer have the stretch-IRA option. Instead, your beneficiaries will have to deplete the account within 10 years or face penalties. This 10-year requirement does not apply to spouses, minor children, or children with disabilities. If your beneficiaries wait until the 10- year mark to withdraw, they face a massive tax bomb.
That said, strategies like the stretch IRA and the conduit trust may be going away. Once the SECURE Act passes, new strategies may emerge.
For instance, people still may be able to utilize tax-bracket management. Even with a 10-year limit, your beneficiaries may be able to take out just enough money to avoid going into the next tax bracket, thus paying more taxes. It’s a fairly common strategy and one to keep in mind going into next year. Of course, you can always convert your traditional IRA to a Roth IRA. If you have a Roth IRA, you don’t have to worry about taxes. High trust tax rates won’t matter. There will never be a tax time bomb waiting around the corner
for your beneficiaries. Life insurance is another option to consider if you want to avoid taxation. Whatever you choose, we’re here to help inform you of your options and recommend the best route to take in your specific case.
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