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  • Writer's pictureJay Judas

Tier One: Understanding IRS Notice 2023-62 - Life Insurance and Wealth Replacement under SECURE Act

Many affluent individuals may never need to touch their qualified plan balances. Prior to the SECURE Act, there was a way to stretch a plan balance over the life of someone from a younger generation. The SECURE Act and SECURE Act 2.0 changed this and now these balances must be stretched over the life of a spouse or taken out within 10 years.


This will lead to some accelerated tax bills. In turn, wealth will be depleted, and steps must then be taken to replace that wealth. This typically means a life insurance solution. For nearly a year, the planning community has been somewhat paralyzed due to the need for clarification on a few provisions in SECURE Act 2.0 – a law that was intended to further advance the intent of the original SECURE Act.


Clarifications about SECURE 2.0 were released in August as part of IRS Notice 2023-62.

Man doing life insurance planning

Understanding IRS Notice 2023-62

Under Section 603 of the SECURE 2.0 Act, a provision was introduced that mandated catch-up contributions for employees aged 50 or over whose wages exceeded $145,000 to be made on a Roth basis. However, in response to industry requests for relief, the IRS has taken a proactive step by providing an administrative transition period. This period extends the compliance deadline until January 1, 2026. As a result, retirement plans have two additional years to adjust to and implement the controversial rule. During this transition period, employees falling within the aforementioned income bracket will not be obligated to make catch-up contributions on a Roth basis. Moreover, plans that do not currently offer Roth contributions will not be required to introduce them until after the transition period concludes.


Weighing the Options: Pre-Tax vs. Roth 401(k) Contributions

The extension of the compliance deadline offers affected employees the opportunity to make considered decisions regarding their catch-up contributions. Those with wages exceeding $145,000 can opt to make their 401(k) catch-up contributions to pretax 401(k) accounts during the transition period. This choice comes with the advantage of income exclusion, which can yield immediate tax benefits. On the other hand, contributing to a Roth 401(k) allows for tax-free accumulation over the long term, including potential benefits for beneficiaries for up to 10 years after the contributor's passing.


While the decision to contribute to pre-tax or Roth 401(k) accounts ultimately depends on individual circumstances, this transition period grants employees the freedom to choose based on their financial goals and tax strategies. It's important for individuals to consult with financial advisors or retirement planning experts to make informed choices that align with their unique situations.


Correcting a Glitch: Restoring Catch-Up Contribution Opportunities

Interestingly, Notice 2023-62 also addresses a technical oversight in the SECURE 2.0 Act. This glitch inadvertently led to the potential elimination of catch-up contributions for all employees starting in 2024. The IRS recognized this error and has taken corrective measures to ensure that catch-up contributions, both pre-tax and Roth, can continue to be made from 2024 onward. This intervention is crucial to maintaining the integrity of retirement planning options and preventing unintended disruptions for savers.


Clarity for High-Paid Self-Employed Individuals

Another aspect of the notice pertains to high-paid self-employed individuals. The IRS has indicated that it intends to offer future guidance clarifying that those with self-employment income, as opposed to traditional "wages," are not subject to the mandatory Roth 401(k) catch-up provision. This clarification is significant for self-employed individuals, as it ensures that they are not inadvertently caught in the scope of the provision.


Role of Life Insurance in Wealth Replacement

To counteract the impact of accelerated distributions and to provide a tax-efficient solution for beneficiaries, life insurance emerges as an effective tool for wealth replacement. Here's how life insurance can play a crucial role:

  1. Wealth Preservation: With the reduced ability to stretch inherited retirement accounts, beneficiaries may face higher tax burdens. A life insurance policy can provide beneficiaries with a tax-free death benefit, helping to offset potential tax liabilities and ensuring the intended wealth transfer.

  2. Tax-Advantaged Growth: Cash value life insurance, such as whole life, variable universal life or indexed universal life, offers a tax-advantaged environment for wealth accumulation. Policyholders can build cash value over time, which can be accessed tax-free through policy loans or withdrawals to supplement retirement income or cover unforeseen expenses.

  3. Estate Planning: For those concerned about estate taxes, life insurance can provide liquidity to cover potential tax obligations without the need to liquidate other assets. This ensures a smoother transfer of wealth to heirs and helps protect the integrity of the estate.

  4. Flexible Beneficiary Designation: Unlike the restricted beneficiary options under the SECURE Act 2.0, life insurance allows policyholders to designate beneficiaries more flexibly. This means that beneficiaries can receive the death benefit according to the policyholder's wishes while potentially avoiding the 10-year distribution requirement.

  5. Legacy Creation: Life insurance can be used to create a lasting legacy by designating a charitable organization as a beneficiary. This aligns with philanthropic goals and can potentially result in estate tax benefits.

Plan Better

IRS Notice 2023-62 sheds light on the changes brought about by the SECURE Act 2.0, emphasizing the importance of adapting retirement and estate planning strategies. Life insurance stands out as a powerful tool for wealth replacement, providing beneficiaries with tax-efficient solutions to counteract the impact of accelerated distributions. By carefully considering your financial situation and seeking professional guidance, you can navigate these changes and secure a more stable financial future for yourself and your family.

 

Since its inception, Life Insurance Strategies Group has solely focused on the individual high net worth life insurance market. We do not sell products. This allows us to offer unbiased, pragmatic advice. Visit us at www.lifeinsurancestrategiesgroup.com.

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