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What Have You Been Doing With Those RMDs?

For years at this time of the year, I would reach out to my clients to discuss their required minimum distribution (RMDs). It is when I would be making sure that those who have not yet taken their RMDs do so by the end of the year. But due to COVID-19, the federal government (through the CARES Act) has provided relief on RMDs for 2020.     

For those who are, or those who will be skipping RMDs for 2020, I pose this question: What were you doing with the after-tax proceeds of RMDs in prior years if you didn’t need them for living expenses? If your RMDs have been building up in bank savings accounts or in taxable investment accounts, you may be a good fit for a tax-planning move to potentially pass on even more to your heirs. 

The Elimination of the Stretch IRA

Tax qualified assets, like 401(k) s and IRAs, are amazing vehicles to grow a nest egg during your lifetime. However, they may not be the most tax friendly assets to inherit for the next generation.  

When the Secure Act was passed in 2019, it effectively did away with the “Stretch IRA,” a tax-favored retirement account that could be passed on from generation to generation. Prior to the SECURE Act, the inherited IRA allowed non-spouse beneficiaries the opportunity to spread out required minimum distributions over their lifetimes, thus spreading out the tax burden. 

The SECURE Act compressed this time period to a maximum of 10 years. Now, non-spouse beneficiaries of an IRA will be taxed at their highest marginal rates likely in their highest earning years. In addition to federal income tax, Pennsylvania and other states currently have inheritance and or estate taxes on IRA assets.  

A Possible Solution for You

You might consider using your unspent RMDs to purchase a life insurance policy that pays out tax-free to your designated beneficiaries. If married, or if you have a partner, you can create a policy that would pay out after the second insured passes away. 

This typically lowers premium costs, can be used to offset taxes, and can provide liquidity when settling an estate. There are three key questions to ask:   

1.     How much can I afford to pass on with this strategy? You must have an adequate next egg and/or a pension to keep you secure in retirement in order to afford the insurance premiums and maintain your lifestyle. Obviously, a financial plan through your Hefren-Tillotson advisor would answer this question.

2.     How much will it cost? No one can truly tell you this unless you go through medical underwriting with an insurance company. Based on the results of medical tests and questionnaires, you will be placed into a rating or risk category. Please keep in mind: you do not have to accept coverage offered by the insurance company. The healthier you are, the lower the risk to the insurance company, and the cheaper the annual cost is to fund.

3.     Is it right for me?  From a tax and estate planning perspective, you will need to understand why (or why not) this decision makes sense. With much discussion with your financial advisor, and a written financial plan, once you are in agreement that it does makes sense, you have cleared the last hurdle.    

Obviously, the above-mentioned strategy is certainly not a fit for everyone. But if you think it matches up well with your goals, here are two reasons to move forward.

·        Regardless of one’s political views, I think we can all agree that taxes in the future will likely be higher. Doing smart tax planning now may be that much more valuable to your situation with the possibility of higher taxes down the road.

·        This planning option may be entirely off the table as one gets older and health issues materialize. The reality is that if you are healthy now, your window of opportunity will not stay open indefinitely.

Take the next step by having this important conversation to get things set in place. If you have questions or concerns, I can help you. Please contact me below!

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Hefren-Tillotson Inc. is a leading diversified financial services firm providing investment and retirement plan management and comprehensive, financial planning through MASTERPLAN® for individuals and businesses. The firm’s wealth management services are administered by Certified Financial Planner (CFP) professionals, Chartered Financial Analyst (CFA) Charter holders, attorneys, Chartered Life Underwriters, and CPA/PFS’s. Hefren-Tillotson offers corporate services including 401(k) retirement planning, executive financial counseling, fiduciary reviews and workplace financial planning seminars. Founded in 1948, the firm is headquartered in Pittsburgh and has offices located in Pittsburgh, Butler, Greensburg, North Hills, and South Hills. MEMBER SIPC.