On this episode of Your Life Simplified, host Daniel Sharkey, senior wealth advisor, is joined by Scott Luhnau, vice president of multi-generational wealth planning, to discuss the SECURE 2.0 Act. They’ll cover what has changed in government legislation, how it impacts 401(k), Roth IRA and other retirement accounts, and why it matters more than ever.

Transcript

Dan Sharkey:

Understanding government legislation is no easy task. Figuring out how it affects you, well that’s even harder today. We’re cutting through the noise with a crash course on the SECURE Act 2.0. What’s changed, how it impacts you, and why it matters more than ever.

Welcome to Your Life Simplified. My name is, Dan Sharkey, Certified Financial Planner and Senior Wealth Advisor here at Mariner. And today I have an extra special guest. Scott Luhnau, is our Vice President of Generational Wealth Planning here at Mariner, and the perfect person to help us unpack the SECURE Act. Scott, welcome to Your Life Simplified.

Scott Luhnau:

Thanks, Dan. Glad to be here.

Dan Sharkey:

Well, it’s great to have you here and I know we have a lot to cover, so I’m just going to dive right in. So for those at home who are listening and just begin to set the table and unpack what we’re here to actually talk about, so what is the SECURE Act 2.0? Why does it matter and why should we be worrying about what it contains in that piece of legislation?

Scott Luhnau:

Great question, Dan. And this is such a pertinent question because it affects so many people. The reason why it’s so important, and everybody should be looking at it, is because retirement plans, IRAs, 401Ks, all types of qualified and non-qualified plans are increasingly becoming the largest asset that we see clients having.

It’s not unusual to see 40, 50, even 75, 80% of a client’s net worth tied up in their retirement accounts. So planning with those assets and doing it in a tax efficient way is more important than ever. Now, the SECURE Act was some legislation that made many changes to retirement plans, and some of them are positive and some of them are negative. So it really depends on your situation, what you need to focus on.

Dan Sharkey:

It’s an excellent point. So when we think about tax planning, what in particular with the SECURE Act should clients be thinking of. I, like you, have a 401K, a lot of our clients have IRAs. How does this impact them directly when it comes to taxes as it relates to the SECURE Act?

Scott Luhnau:

Good question. So in the SECURE Act they created, they meaning the IRS, they created these different classes of beneficiaries. So they’re called EDBs, which is Eligible, Designated, Beneficiaries. This is like the preferred class that gets the best tax treatment. So you want to be an EDB. The next category is called a Designated Beneficiary or a Non-Eligible Designated Beneficiary. And the last one, which you don’t want to be in this class, is a Non-Designated Beneficiary. So as you go down the slope, the tax treatment is worse as you get towards a Non-Designated Beneficiary.

Now, the good news is if you’re married, your situation is going to be easy because if you’re married, most of the time you’re just going to leave your qualified accounts to your surviving spouse and they still get the best tax treatment. They can do a spousal rollover or they can treat it as their own. They have really good options that can continue that tax deferral, which is one of the great features of a retirement plan until the surviving spouse reaches requirement beginning day.

But if you’re not married or you’re not going to leave your retirement accounts to your spouse and you’re going to leave them to other people in your family, that’s when you really, really have to be careful about planning in a tax-efficient way so that you don’t have to pay more tax than you have to.

Dan Sharkey:

It’s a really excellent point, and let me just set the table for what has changed. So a lot of clients come to us and say, “No, no, no, I can actually inherit these assets and stretch them out over my lifetime.” Has that rule changed and what’s different today than what had been part of the IRS code previously?

Scott Luhnau:

Right. So you remember at the beginning, Dan, I said they made a lot of changes and some of them were positive and some of them were negative. So the way I like to put it is the IRS giveth and the IRS taketh.

So they’re not going to give you all of these benefits unless they take something away. So they thought, “You know what? Pre-SECURE Act, when you’re a non-spouse and you inherited an IRA, you could…” It was called a Stretch IRA. So you would inherit the IRA and then you would be able to take distributions over your remaining life expectancy. So if a forty-year-old person inherited an IRA from a parent, say, and their life expectancy was say 85. Well, that’s another 45 years of stretch of that IRA before it is exhausted. It’s a wonderful deal. “Well, if it’s a wonderful deal, we are going to figure out how to take it away from you.”

Dan Sharkey:

That’s right.

Scott Luhnau:

So the biggest downfall or the worst thing for taxpayers about the SECURE Act is that now there’s this thing called the 10-year rule, the 10-year rule. So if you’re not one of these eligible designated beneficiaries, now you’re going to be forced to take a full distribution of that IRA within 10 years of that person’s death. So what the IRS is forcing you to do is to accelerate the payment of those taxes. So instead of having it over your life expectancy, now the IRS is going to collect all the tax within 10 years of that person’s death. So that’s really the biggest downfall with the SECURE Act that you have to watch out for.

Dan Sharkey:

And let me just put that in context because I think that’s an excellent point that everyone really needs to pay attention to. Let’s say, and God willing, this doesn’t happen for a long time, but I inherit an IRA from my parents. Previously… I’m 40 right now, that would have been stretched out, as you pointed out, Scott, over the course of my lifetime.

But what clients need to recognize, both in terms of those who have the IRA assets and the beneficiaries, is that I’m likely in my prime earning years, that income that I’m going to have to recognize over that ten-year period is going to be taxed at what is likely the highest income tax rate that I face in my lifetime. So in terms of what the tax burden ultimately becomes, it’s significantly higher now than it has been previously under the Stretch IRA provisions. Would that be a good way to summarize it?

Scott Luhnau:

Yeah. The other way I would put it is, and you’ve just hit the nail on the head, Dan, by being forced to take these IRA distributions for a lot of people, it’s going to kick you into a higher tax bracket, if not the highest tax bracket. Just this morning, I was helping an advisor who’s dealing with a beneficiary who’s probably going to get a $6.5 million IRA from her uncle.

Not all IRAs are that big, but again, you’re seeing larger and larger ones. So how do you do that in a tax-efficient way? So one of the techniques that I’m seeing more and more now is when it’s a non-spouse beneficiary. Obviously if you’re married, you want to leave it to your spouse if that’s appropriate. But if you’re going to leave it to a non-spouse, I highly recommend considering whether a Charitable Remainder Trust is appropriate.

The Charitable Remainder Trust will basically allow you to circumvent or negate the ten-year rule, because the Charitable Remainder Trust will pay out an income stream for the rest of the beneficiary’s lifetime, plus it’ll give your estate a charitable deduction which could reduce your estate taxes. So it’s kind of a dual benefit.

Now, if you have this small IRA, it’s probably not worth doing that. So if you have an IRA that’s more than, say, 750,000, million dollars and up, a Charitable Remainder Trust is really a good technique to consider if that’s right for you.

Dan Sharkey:

You just highlighted also why it’s important to make sure that you really understand all the options that are at your disposal. Too often we see clients who come to us here at Mariner with a default option without really understanding what the rules are. So by working with an advisor, really having an understanding about what the choices are, you can really put yourself in a more advantageous position as it relates to passing that wealth down to the next generation.

So let’s just talk a little bit more about estate planning. As multiple studies have shown, we are in the midst from the baby boomer generation about the greatest wealth transfer in US history. What other opportunities or challenges does a SECURE Act 2.0 present, and particularly in terms of wealth transfer, which I know is your area of expertise that beneficiaries and asset owners should be thinking about, take advantage of those new rules?

Scott Luhnau:

So just one thought before I answer that question. I think if there’s going to be one key takeaway from the segment on the SECURE Act is that everyone, if you haven’t done it recently, just check your beneficiary designations. Just last week, an advisor again came for some assistance. A client had died and they had multiple IRAs. And on two of those IRAs, they failed or neglected to name a beneficiary for whatever reason that fell through the cracks, and there’s no beneficiary designation form.

Remember those three classes of beneficiaries I talked about? The worst one is the Non-Designated Beneficiary. Well, the IRS rule is clear. If you fail to name a beneficiary, the default is your estate. It just goes to your estate, and that’s the worst tax treatment because now it’s what’s called the five-year rule. The IRA has to be fully distributed within five years of death. So again, the takeaway here is take a look at your beneficiary designations and make sure they’re up-to-date.

So estate taxes. Dan, if you have a taxable estate, my view is that an IRA is a toxic asset. Now, you may say, “Whoa, Scott, that’s A harsh word to use, toxic.” But it’s true. If you have a taxable estate, think about this. The IRA is going to generate a 40% estate tax based on the value of the IRA. So if you have a million dollar IRA, that’s $400,000 of estate tax that now has to be paid because that IRA exists.

Now, if that IRA passes to a beneficiary whose say, in the 30% tax bracket, 70 cents on the dollar now is going to be lost because of that IRA. So in larger estates, what we’re talking about with clients is, “Look, if you take all of your other assets and your children inherit those assets, is that a sufficient amount of inheritance? Is that the right amount of inheritance that will take care of them financially, provide financial security and all of those wonderful things?”

And if the answer is yes, well guess what? Leave the IRA straight to charity because then you’ll get a dollar for dollar estate tax deduction. You can totally eliminate or significantly reduce your estate tax if you go the root of charitable planning with your IRAs. And if you’re not comfortable leaving it at all the charity, that’s when the Charitable Remainder Trust is the next best thing because you still get a charitable deduction, but your kids then also benefit from that IRA.

Dan Sharkey:

It’s one of the amazing things in the tax code that allows you to have your cake and eat it too. So to really summarize, I want to bring up back one last point that you made that was exquisite relating to checking your beneficiaries on your IRAs or any tax-deferred account really. Just as a reminder that everyone listening, that is at what’s called a non-probate asset, meaning wherever the beneficiary is listed on that form will get the proceeds of that account.

Now, why is that important? Oftentimes what we see are people who have accounts that they’ve lost track of. Perhaps they designated a beneficiary before they had their full family built out and before they had other relationships that are important to them. So it’s doubly important to check those beneficiaries to make sure that the assets will be passed to the people that you designate, not who you wrote on a form 20 years ago and simply forgot about.

So just a quick public service reminder because I can speak from personal experience and family that those things do happen and we want to avoid them whenever we can.

So just to summarize a couple of key takeaways that we want to have from today. Figuring out how to pass your assets most efficiently based on the type of beneficiary that there are, making sure that we check our beneficiary forms. And I would say most importantly, particularly for those who have taxable estates, be mindful of these other techniques that you can utilize and call your advisor to make sure that you have clear understanding, being able to benefit charity, benefit your heirs all in a much more tax-efficient way is a key takeaway.

Scott Luhnau:

Dan, let me just add one last thing, and I won’t go into detail because this is getting complicated. But if you’re going to leave your IRA to children, one of the questions we always ask is, “Okay, that’s great. Should your children receive their inheritance outright or in trust?” And there’s a lot of factors that affect that, such as their financial maturity, what career they’re in, their age, and all of those things.

You can leave IRAs to trusts for children, but there are very specific rules that govern that. So if you’re considering not leaving an outright to a child for whatever reason, but instead using trusts, check with your financial advisor because they can help you figure out how to best structure that. So just keep that in mind.

Dan Sharkey:

That’s absolutely great. Terrific advice. So thank you, Scott, for being so generous with your time. We’ve been speaking with, Scott Luhnau, Mariners Vice President of Generational Wealth Transfer. And if you enjoyed this conversation, please make sure to hit that subscribe button so you don’t miss out on any previous or future conversations that we have, Apple, YouTube, wherever you get your podcasts, and wherever else you listen to us. Thanks again for tuning in and make it a great day.

Scott Luhnau:

Thanks, Dan.

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