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Ed Slott on RMDs, Backdoor Roths and the Death of the Stretch IRA

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Ed Slott, the Rockville Centre, New York-based CPA, editor of the newsletter Ed Slott’s IRA Advisor, and author of “The New Retirement Savings Time Bomb” (Penguin Books), to be released in March, recently talked to ThinkAdvisor with some advice about how tax law changes. Here are excerpts from our interview:

THINKADVISOR: One of the biggest regulatory changes of late was the Setting Every Community Up for Retirement Enhancement (Secure) Act. What do advisors need to understand about it?

ED SLOTT: Many things. For example, the age at which you have to start taking money out of a retirement account — the required minimum distribution — moved from 70 1/2 to 72.

There’s a penalty if you don’t do it. In addition, you have to calculate how much needs to come out of every retirement account you own. It can get complicated. If advisors don’t keep up, they could cost clients a fortune in needless and excessive taxes.

The Secure Act also eliminated the so-called “stretch IRA,” which allowed an IRA to be passed on to a non-spouse beneficiary — that is, from generation to generation — while maintaining the tax advantages. But now, many non-spouse heirs will have to empty inherited retirement accounts within 10 years. Why does that matter?

It upends a planning tool that people have counted on for years. It’s a broken promise. Congress pulled the rug out from under us in the ninth inning, if you’ll pardon the mixed metaphor. But there are a few solutions.

For many people, permanent cash-value life insurance is a great replacement for the stretch IRA. It’s actually a better long-term planning vehicle and gives you a larger inheritance, more control, and less of a tax burden.

Even if you’re single or have no dependents, it can be a great vehicle because you can be your own beneficiary, without dying.

The cash value that builds up can be accessed tax-free during your lifetime. And by the way, I don’t sell insurance. This is unbiased advice.

In fact, you call life insurance the “single biggest benefit of the tax code.” Why?

Because the money comes in tax-free, and all of the return is income-tax-free. In addition, unlike IRAs and Roth IRAs, the payout can also be estate-tax-free.

You can leave it to a trust — life insurance is the most flexible vehicle to fund a trust with.

You can use an IRA to fund a trust, but it’s complicated and many people run afoul of the rules, causing excessive trust taxes. Life insurance removes all of those complications and risks.

But life insurance can be expensive, and not everyone qualifies.

Right. Life insurance isn’t for everybody. None of these solutions are one-size-fits-all. You have to customize.

So what’s another good choice?

I’m a big fan of the Roth IRA. A Roth IRA is completely tax free, where a traditional IRA just defers taxes until you withdraw the money. And with a Roth, there is no RMD at age 72. The money can stay there as long as you like.

You can convert your IRAs to Roths. When you do, you’ll have to pay the tax upfront, but you get a better result later on.

People shouldn’t be overly concerned about the immediate costs. Rather, look at the lifespan of the decision, the long-term implications. With a Roth IRA, you end up with much more at the end of the game.

Plus, you don’t have to convert all your IRAs at once. It’s a permanent conversion, and for some people, it makes more sense to do a series of small conversions every year or so.

What is the “backdoor Roth for high-income earners”?

A: It’s a way to get money into a Roth IRA even if, technically, you make too much money. [To contribute to a Roth IRA, an individual's Modified Adjusted Gross Income must be less than $139,000 in 2020, or less than $203,000 for married couples who file jointly.]

You start with a traditional IRA — and the SECURE Act allows contributions to traditional IRAs even after age 70 1/2, which you couldn’t do before. You then convert the IRA to a Roth. It may sound devious, but it’s a completely legal workaround.

What do people need to know about avoiding estate taxes through gifting?

A: There are huge gifting advantages now where you can get money out at low or no tax costs. You can gift up to $15,000 a year to as many people as you wish without counting against your lifetime exemption [currently $11.58 million].

Very wealthy people who are worried their estate might be large enough to generate an estate tax should consider getting rid of a lot of their assets now, through gifting.

Most people aren’t subject to the estate tax, but you never know when Congress might tighten that up and it won’t just be the super wealthy who have to worry about it.

Do you think the new administration might change the tax rules again?

I doubt it. They have plenty of other things to keep them busy. But you never know. The tax rules are fluid, which is why it’s so important to stay up to date.

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