Secure Act Blues

On 1/1/2020 there is a new law in town. The stretch method of wealth transfer will be kaput. The government has devised a new schedule that will assure them a lions share of your wealth upon your death. They will do it by nailing your children to the cross.

There are typically 4 asset classes that transfer IRA, Roth, Brokerage, Real Estate. in 2019 you could dissolve the assets in the IRA and the Roth as an heir over a very long time, even into your next generation i.e. the grand kids. You could leave the kids an IRA say IRA 1, but you could also name grand kids as beneficiaries in a separate IRA called IRA 2 which could grow unmolested for decades. Kids get money, pay ordinary income tax, but had control over how much income is removed so they had some control over taxes. No more. Starting next year Roth and TIRA needs to be emptied within 10 years of inheritance. If you have a combined 2M IRA and it grows at 5% your kid has to pull out $260K/yr as ordinary income. Depending on his income this could easily put him in the top tax bracket for 10 years, accelerating his tax bill and allowing the government a larger slice of your money than they otherwise have enjoyed.

This maneuver isolates the politicians. By the time you’re dead and your kids take over the money, the law is seasoned and “no one” is to blame. As a voting block the kids don’t even know they’ve been fleeced, and the grand kids don’t have the first clue. What’s a mother to do?

I’ve been playing with using the power of compounding, mixed with the power of lower tax rates to come up with an inter-generational solution using the gift tax. Each parent can gift 15K/yr per kid tax free, so if you have 2 parents and 3 kids you can gift up to 90K/yr. If you have 3 kids and 3 grand kids that becomes 180K/yr. What you want to do is set up a schedule of disbursement that eats into the principal of the IRA over the projected course of your life span. So if you start with 2M at 5% interest and have 20 years to live you need to pull out 160K/yr to empty the account in 20 years. 100K /yr keeps the account steady state at 2M. This gives you good control over disbursement. If you want to keep some money in those accounts till you die simply take out an amount somewhere in the middle. Lets say you pull out 130K/yr at the end of 20 years you would have $1M left in the accounts and would have transferred $4.3M in net value to your kids if they just put that money away and let it dollar cost average and compound for 20 years. This uses the tax law and compounding as a means of transferring a ton of wealth. In addition There will still be 1M in the accounts which will be disbursed over 10 years @ 130K/yr. By varying the disbursement vs the residual you can figure what disbursement is optimal for a given progressive tax code.

Your eyes may pop out at this and ask how can this be true? The answer is your money compounds no matter who owns it. If you start with 2M at 5% and never remove a dime after 20 years you will have 5.3M, the same 5.3 M you wound up with except you transferred 4.3M of that at a low tax rate and then had the additional 1M still in your account at the time of death. More money stays in your family less money goes to Uncle Sam. The particulars matter however. You can’t do this rule of thumb. You have to mathematically optimize and minimize taxes across 2 or more generations. Certainly a gamble but a gamble with a highly likely outcome since no one else is going to do the work involved in the optimization. The governments rules are designed to slaughter most of the people and it’s hard to write a law that covers 100% if there is some wiggle room and there is wiggle room.

A second strategy would be to take money in excess of RMD from the accounts and stick that in a brokerage. You would have to pay ordinary income taxes but if you optimized into a Roth you can pull Roth money into a brokerage tax free. Upon death the brokerage receives a step up in basis to the heir, and a brokerage has no expiration and a different taxation regimen. In addition, as the heir you may be able to tax loss harvest the brokerage over a long time, turning at least part of that account into a Roth like asset or a partial Roth like asset. You also have control over how much you take out depending on other income sources further optimizing your tax bill.

It’s complicated but it’s a puzzle that can be solved, and is worth being solved. I don’t have the details worked out yet, just the general framework, but my preliminary massage of the data shows this should work quite nicely.

9 Replies to “Secure Act Blues”

  1. Hey Gasem,

    The only sure thing in life is change. I plan to gift as much as is healthy for my kids while we are alive. I look at family wealth as well. Otherwise it all ends up in the government’s pockets.

    I look forward to your ongoing analysis on this.

  2. I’ll look forward to the analysis, but the gifting idea passes the sniff test.

    The assurance that Uncle Sam will place a lump of coal in every stocking never ceases to amaze me.

    Still curious if cash flowing real estate, with the step up in basis, will permit a “virtual” stretch to take place. Reading up on this lately, in part because the tax treatment for real estate professional status is favorable enough that a couple of duplexes can have a big impact on tax treatment.

    1. Personally I would never do a business deal based on the presumed tax consequence alone. I would own some duplexes because that business suits your temperament and if there is some available tax advantage good deal. Neither would I do a deal without a clear exit strategy. I did a beach front condo deal 30 years ago where I was an owner of 3 rental condos. One was meant for our retirements and the other 2 designed to finance that. The management company decided they wanted to turn the property into a condo hotel, so they decided to renovate. The other owners, the Dentists in Akron, soon ran into cash flow problems because the mortgage was due and there was no revenue because the place was closed for construction. Essentially the management company was using the mortgages of the other owners to finance the renovation. Soon enough they sold out at a loss. I hung in until I was one of the last left, and in order for them to take over complete ownership I was able to get out at par, but there was several years of heart burn associated with that deal. Buying me out at par was the keys to their kingdom. Homey don’t play that no more. Illiquidity is not your friend.

  3. I know in the past you haven’t been a fan of using a DAF for charitable giving. Any thoughts on using one now that SECURE will be a reality? Combining Roth conversions with money you were planning on giving away anyways seems like a win-win situation.

    1. I think it depends to what length you are willing to go to screw with the government. In the end you are the fly and they own the swatter. How a gun works, is it is a mechanism designed to allow you to hold an explosion in your hand and not pull back a bloody stump. Works great till it doesn’t.

  4. I was looking over the Kitches article
    https://www.kitces.com/blog/secure-act-2019-stretch-ira-rmd-effective-date-mep-auto-enrollment/
    And Roth post death won’t be taxed but heirs will need to clean out the account within 10 years. You can contribute to a Roth at any age as long as it’s ordinary income, and as long as if it’s from an IRA, it’s income above the RMD.

    This means the Roth can grow for as long as 10 years after inheritance and then the money needs to be removed but it’s tax free. The obvious solution is to continue to make Roth contributions or Roth conversions into the Roth after age 72 or when you start pulling money out of the IRA. Roth contributions need to be money over and above RMD money. So if you need to pull 20K out of the IRA you could pull that 20K and add an additional amount above 20K into the Roth and pay taxes on the whole shooting match.

    If your income was 45K taxable for SS and 20K from RMD and you take the standard deduction and were MFJ you would have an additional 36K you could Roth convert and still remain in the 12% capital gains advantaged bracket. This way you pay the taxes at a low 12% rate and DCA more money into the Roth for inheritance. Should you need the Roth money for your life expenses it would still be in your account. You could also do the Roth conversion and do the gifting at the same time, and over a couple decades transfer quite a bit of wealth.

    1. That’s a great idea and I’ve already seen it done my father. He passed away earlier this year so I’ve been handling my mother’s financial affairs and got to peek behind the curtain. Since my parents have always been very frugal they could essentially live on SS plus a little extra from their taxable, the RMD was an inconvenient taxable event. Starting in 2010 when conversions were allowed he started converting his tIRA to Roth, a fairly large initial amount then filling the lower tax brackets in subsequent years. From 100% pre-tax, only 25% is now tIRA, the rest is Roth. I plan to continue this plan for my mother, its already been presented in a mainstream financial article:
      https://www.forbes.com/sites/leonlabrecque/2019/12/26/the-mom-roth–intergenerational-roth-conversion-after-the-secure-act/#21a1a41539fb

      1. Tnx GF I was writing an article when you sent this. I looked over the Forbes article and somewhat similar to mine, but mine is more heavy on the pre RMD conversions and Mom’s Roth is more heavy on topping up the to the top of a bracket. You of course can do both!

Leave a Reply

Your email address will not be published. Required fields are marked *