Planning for a SECURE Transfer to Your Next Generation

By Jesse W. Hurst, CFP®, AIF®, Senior Wealth Manager and CEO at Impel Wealth Management, and Julie E. Firestone, Principal at Singerman, Mills, Desberg & Kauntz Co., L.P.A.

Thirty years ago, in the pre-First Energy days, Ohio Edison hired my (Jesse Hurst's) firm to teach retirement planning workshops to their salaried employees age 55 and older who were being given early retirement buyouts. We conducted a series of three workshops covering various retirement, investment, and estate planning topics.

At that time, the federal estate tax exemption amount was $600,000 per person, and the minimum federal estate tax bracket was 37%. With proper planning, a married couple could pass $1.2 million to their children without estate tax. Proper planning was required because, at the time, the exemption amount of one spouse could not be combined with the exemption amount of the other spouse. That meant the assets of a couple worth $1.2 million and who left everything outright to the survivor would have been subject to an estate tax on $600,000 worth of property because the surviving spouse only had his or her own exemption amount of $600,000.

As a result, we estate planning attorneys (Julie Firestone) would often create a revocable living trust, sometimes known as an A-B trust. Along with proper titling and beneficiary designations, this would allow both spouses to utilize their $600,000 estate tax exemptions. However, a couple's estate of more than $1.2 million still faced sizable estate taxes. To help clients meet their goals of passing along hard-earned wealth to their children, we advisors would then often use combined legal and financial estate planning tools, such as an irrevocable life insurance trust (ILIT), funded with a survivorship life insurance policy that would provide liquidity to pay the projected estate tax at the time.

Subsequently, President Bill Clinton signed the Taxpayer Relief Act of 1997 into law. The estate tax exemption gradually rose from $600,000 to $1 million by 2006. Under President George W. Bush, additional legislation was enacted that increased the exemption to $3 million. When President Obama took office, this was increased to $5 million. The amount was doubled again under President Trump and other changes were enacted that made estate taxes less of a concern for many taxpayers.

Included in the tax law changes that helped people to pass along more wealth to their children tax-free were an annual, automatic cost-of-living adjustment and portability between spouses (meaning spouses could now combine their exemption amounts), negating the need for trusts with A-B language for many estates. The estate tax exemption amount in 2024 now stands at $13.61 million per person, or more than $27.2 million for a married couple. (Note that under existing legislation, this amount will decrease in 2026 to an inflated adjusted amount expected to be in the range of $6 million to $7 million per person. Married couples will still be able to combine their exemption amounts via portability.)

As a result of these increases in the exemption amount and the ease of spouses being able to combine their exemption amounts, the use of survivorship life insurance for emerging affluent people – particularly those with a net worth from $2 million to $10 million, many for whom those amounts are held in retirement plan assets – fell dramatically, as they no longer faced any estate tax liability. And while the changes in the estate tax laws have made it less likely these people will owe estate tax, making survivorship life insurance seem unnecessary, the passage of the SECURE Act and SECURE Act 2.0 have made it more likely that the heirs of these people will owe significantly more in income tax. For people in this net worth range, it may be time to reconsider using that existing (or to consider acquiring a new) survivorship life insurance policy to reduce the future income tax liability for their children and grandchildren who will inherit their retirement plan assets.

Prior to 2020, a common tax minimization strategy was for a couple to defer taking distributions from retirement plan assets for as long as possible and then to leave such assets to the survivor of them and then to their children, each person having the ability also to defer distributions, only taking out the minimum required amount ("RMDs") over their life expectancy, which for the children could be 30 years or more. Due to the compounded effect of good financial habits, it is common to find executives with an accumulated net worth of $3 million to $5 million or more, with half or more in retirement plan dollars that have not been subject to income taxes (yet). The benefit of that old strategy was that income tax liability could be spread over several decades.

With the passage of the SECURE Act, most heirs are now required to distribute all taxable retirement plan assets by the end of 10 years. This means children who inherit retirement plan assets have to take larger taxable distributions over a shorter period of time and possibly during their peak earning years, creating large income-tax liabilities for them. Many people are uncomfortable with the idea of saddling their children with these potentially large income-tax liabilities and are once again exploring the use of survivorship life insurance to help manage and reduce the overall tax burden imposed upon these assets intended to be passed on to heirs.

Jesse Hurst can illustrate this concept with a real-life example. The names have been changed to protect confidentiality.

Tom and Karen have been my (Jesse's) clients for many years. They are now age 68 and 66. They have one daughter, a very successful salesperson in her late 30s. She is married to an attorney, who is also doing well in his career. Combined, the daughter and her husband make more than $400,000 a year.

Tom and Karen's estate is valued at $4 million. Approximately $2.4 million of it is in a retirement account. If Tom and Karen were to pass away under the current rules and name their daughter as the beneficiary of this $2.4 million retirement account, there would be no estate tax due, but the retirement account would have to be distributed to their daughter by the end of 10 years (rather than over her life expectancy, as before). Assuming a 5% return on the inherited retirement account, levelized payments to the daughter would exceed $300,000 annually, which, when combined with her work income, could subject their daughter to a marginal income tax rate comparable to the estate tax rate from 1984. As you can see, the effect of these tax law changes is they have essentially swapped an income tax for the estate tax.  

To help solve this problem, rather than the old strategy of deferring retirement distributions (and the corresponding income taxes) as long as possible, Tom and Karen will adopt a new strategy of spreading the distributions (and corresponding income taxes) over as many years (and lower income tax brackets) as they can. They now plan to withdraw approximately 2% of the account value annually, even before age 73, the required beginning date for RMDs. They will pay tax on this $48,000 per year. Since they are debt-free and live a relatively conservative lifestyle, under current tax law, part of the distribution will be taxed at the 12% federal rate and the balance at 22%. They will deposit the net amount into a survivorship life insurance policy, which has a face value of $1.5 million. This will allow them to create a pool of money that will go to their daughter upon the second spouse's passing. Under current law, this is income – and estate – tax-free, and we have removed the 10-year payout mandate to the daughter.

Additionally, when Tom turns 70 ½, they can use additional qualified charitable distributions from the retirement plan assets to further reduce their IRA balance and fulfill some of their charitable funding goals. In essence, the life insurance policy proceeds, in addition to their existing assets, allow them to give more money away to both their children and to charity, all while reducing taxes.

Utilizing this strategy, everyone wins. Tom and Karen get to see their hard-earned assets go to their daughter in an income tax-efficient manner, and they get to fund their charitable goals with tax-free gifts.

We wanted to share this strategy with our professional advisor colleagues, as it may be appropriate for a number of your emerging affluent clients going forward. We hope that the strategy and the history lesson provide context and value for you and your clients in the future.

Did You Know?

The "Legacy IRA" provisions of SECURE 2.0 make qualified charitable distributions even more attractive because taxpayers may now make a one-time QCD transfer to a charitable gift annuity (CGA) or charitable remainder trust (CRT). Both CGAs and CRTs are life income gifts, meaning the donor receives a fixed income stream during their lifetime while benefiting their chosen charity in the future. Charitable gift annuities can be established through Akron Community Foundation, with the remaining assets supporting or creating a nonprofit endowment fund. Contact us to learn more.

This content is provided for informational purposes only. It is not intended as legal, accounting, or financial planning advice.