A SECURE Act Solution: A Five Year Loan to Your IRA


My colleagues at NAELA and I have been poring over the SECURE Act for many months, from the time it was introduced as legislation until its eventual passage at the very end of December 2019.

We were able to make some changes to it because early on we spotted a few problems with the limitations to the Stretch IRA elimination. Our recommendations to include disabled children, minor children and a few other exceptions to the ten-year limit were adopted into the bill.

Since it has become law, Elder Law attorneys, CPAs, and financial professionals have been trying to figure out the best way to work around this ten-year rule. There’s talk about buying insurance, using annuities and a few other strategies. My suggestion is a bit more straightforward

Many IRA owners find when they reach the age for Required Minimum Distributions (RMDs) to begin, they really do not need the distribution but still must pay the income tax on the distribution.

Roth IRAs do not require any mandatory distributions and five years after you convert to a Roth IRA, any distribution to you or your beneficiaries is income tax-free. The downside is you must pay income tax on the entire $500,000 in the year you convert to a Roth IRA.

Think of this approach as a five-year loan to your IRA to make your IRA income tax-free to you and your family.

Income tax rates are currently low, and since there’s no way to know if they are going to remain that way, this might be something to do sooner, rather than later. Bear in mind that the SECURE Act’s change to the stretch IRA distribution rule was designed to generate needed tax revenues. It’s likely that taxes may go up in the future.

Let’s say you convert a $500,000 traditional IRA to a Roth IRA. Your tax bill will be $120,000. But over the next five years, that $500,000 is going grow tax-free on a compounded basis. Let’s examine how this works.

Let’s assume a rate of return in the IRA is seven percent and you pay the income tax from your other assets. During the five years after you convert to a Roth IRA, you do not have to take any distributions. At the end of the five-year period, the value of the IRA grows to over $750,000. You can now take back the $120,000 from the Roth IRA. And you are not subject to the mandatory required distribution rules; if you make a distribution, it is income tax-free. If you take no distributions, the Roth IRA will pass to your beneficiaries and is income tax-free to them. It is a win-win proposition.

You can then do whatever estate planning is necessary to distribute the money as you and your estate planning attorney, CPA and financial advisor feel are appropriate.

Is it worth the initial outlay? That’s a very personal decision, but it may bear consideration.

Article submitted by Stephen Silverberg  of the Law Office of Stephen J. Silverberg in Roslyn


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