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Avoiding the Tax Double Whammy

Updated: Jun 10

Avoiding the tax double whammy

In the ever-evolving realm of wealth management, safeguarding assets for future generations is a top priority. Recent legislative changes, notably the SECURE Act of 2019 and the upcoming sunset of the Tax Cuts and Jobs Act (TCJA) in 2025, pose significant challenges to this goal. These two factors create a "one-two punch" that threatens to erode the value of assets left in IRAs for beneficiaries. However, with strategic planning and foresight, you can help clients navigate these changes and protect their legacies.

Most are well aware of the massive amount of wealth held in retirement accounts. What may not be as well known outside the financial planning community is how significantly those assets will be eroded as they pass to the next generation. Simply considering the income tax implications points to the SECURE Act of 2019 as an accelerant of sorts. Previously, beneficiaries could "stretch" distributions over their lifetimes, effectively minimizing annual tax liabilities. Now, most beneficiaries must distribute the inherited IRA within a ten-year period. This accelerated distribution schedule can push beneficiaries into higher tax brackets, leading to substantial tax burdens and reducing the overall inheritance.

The second element of this planning challenge is on the horizon: The sunset of the Tax Cuts and Jobs Act (TCJA) at the end of 2025. While much of the discussion of the sunset focuses on changes to estate tax laws, for IRA beneficiaries the changes to income tax rates may be more important. Why? Just as they are being forced to take large, taxable distributions from their inherited IRA, the rate at which those distributions are taxed is due to increase when the TCJA sunsets.

This has major implications for both those who are in the ten-year distribution phase as well as those anticipating inheriting an IRA.

Strategic Responses to the Tax Double Whammy

  1. Accelerate IRA Distributions Before the TCJA Sunset

For those already in the process of distributing an inherited IRA, a quick look at the potential increase in income tax rates based on the TCJA sunset as shown in Table 1 indicates an increase of anywhere from 0% to 4% in marginal tax rates for taxpayers filing jointly as rates revert to 2017 levels. Depending on the rest of the client’s income tax planning, it may make sense to accelerate distributions of the IRA prior to the TCJA sunset to avoid these higher rates.

Table 1

2. Pre-Inheritance Planning: Life Insurance Solutions 

Those anticipating an IRA inheritance, further accelerating those distributions likely doesn’t help, as it would have to be on such a short timeline that the increased would undoubtedly result in the client jumping up to a higher income tax bracket. For these clients, the planning work has to happen before the inheritance is received.

In this case, the fact that approximately 36% of retirees who withdrew funds from a traditional IRA in 2021 used the money to reinvest or save. The likely cause of these distributions is undoubtedly Required Minimum Distributions that force the IRA owner to liquidate a portion of their IRA each year once they reach a certain age. The question for this discussion is what are these clients doing with the money? Where are they investing it? 

From the perspective of the beneficiary anticipating receiving the IRA as an inheritance or the IRA owner concerned about so much of their hard-earned money being lost to taxes, a life insurance policy may be the best vehicle for a few simple reasons:

  • Leverage Premium Dollars: Each premium dollar can significantly increase the amount passed to the next generation.

  • Tax-Free Proceeds: Life insurance proceeds are generally income tax-free, offering a clear advantage over taxable IRA distributions.

  • Estate Tax Benefits: With proper planning, life insurance proceeds can also pass estate tax-free.

By addressing the implications of the SECURE Act and the forthcoming TCJA sunset through thoughtful planning and innovative strategies like leveraging life insurance, you can protect your clients' assets from the "tax double whammy." Proactive guidance today ensures that your clients' wealth remains intact and passes smoothly to future generations, securing their financial legacy for years to come. For expert assistance in navigating these complex changes and implementing effective wealth preservation strategies, contact NFP Insurance Solutions today.




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