On December 20, 2019, President Trump signed into law the “Setting Every Community Up for Retirement Enhancement Act” (the SECURE Act). This new law changes how IRAs and certain other retirement benefits must be treated after death. These changes are significant, and they may affect your existing estate plan.
With just a few exceptions, which I will explain below, the passage of the new SECURE Act eliminates the ability of a beneficiary of your retirement plan to stretch their receipt of those proceeds out over an extended period of time.
For example, in the case of an IRA, prior to the SECURE Act your beneficiary had the option to stretch his or her required annual minimum distributions over his or her life expectancy. This allowed the beneficiary to defer income tax while permitting the balance to compound. This was a very nice benefit, especially for beneficiaries who were much younger than the owner of the IRA. But now under the SECURE Act, most beneficiaries inheriting an IRA (or other defined contribution plans) will be required to completely withdraw all plan assets within 10 year of the date of the owner’s death.
As mentioned above, there are a few exceptions to this new 10-year payout rule. Those heirs who meet the definition of “eligible designated beneficiaries” under the SECURE Act may still withdraw their share of the plan assets over their life expectancy. For all other beneficiaries, the concept of Required Minimum Distributions (RMDs) has been eliminated, and the new 10-year payout rule applies.
Who is an Eligible Beneficiary?
So, who is an “eligible designated beneficiary” under the new law? These individuals include the following:
- Surviving spouses.
- Chronically ill heirs (as defined under the IRS rules).
- Disabled heirs (as defined under the IRS rules).
- Minor children, but the 10-year rule applies when the child reaches age of majority.
- Individuals not more than 10-years younger than the IRA owner.
Once again, if a beneficiary does not qualify as an “eligible designated beneficiary” under one or more of the five exceptions above, he or she will be required to completely withdraw his or her entire share of the plan assets within 10-years of your death.
How Does the New Law Affect Conduit Trusts?
If your present estate plan includes a revocable living trust, that trust may contain conduit provisions, which upon your death, are designed to allow the trustee to draw the required minimum distributions from your IRA based upon the remaining life expectancy of the trust beneficiary or beneficiaries. Such provisions were likely included in your trust in order to defer income tax consequences by stretching the distributions, while protecting the balance of the plan from a beneficiary’s lifetime circumstances, legal issues, or financial irresponsibility.
However, since the SECURE Act now eliminates the use of Required Minimum Distributions (except for “eligible designated beneficiaries” as mentioned above), any IRA or other defined contribution plan designated to pass to your trust as the result of your death would be subject to some unintended consequences. That is, as for any such plans payable to your trust after your death, there would be no payouts until the end of the 10-year period, at which time all of the funds would be payable to your trust to be distributed to the trust beneficiary. And, all taxes would be payable at that time. This is obviously contrary to the original objective of allowing the trustee to draw the required minimum distributions out over the beneficiary’s lifetime, while maintaining control over the funds not yet distributed from the plan.
So, What’s the Next Step?
While the SECURE Act has the potential to generate billions of dollars of tax revenue in the years to come, its negative effects on a beneficiary’s stretch strategy, and undesirable consequences for benefits passing to a conduit trust, will require that all participants of an IRA or other defined contribution plan re-evaluate their planning options.
For those who have designated a spouse as the primary beneficiary of their IRA or other defined contribution plan, RMD rules will remain the same under the new law as they were under the previous law. However, for those of you who have designated your conduit trust as the primary or contingent (secondary) beneficiary of your IRAs or other plan(s), a change would be required at this time in order to avoid the negative implications discussed above.
Some plan participants may choose to designate their children (or other family members or individuals) as the direct beneficiaries of their IRAs and other plans, to receive the proceeds of such plans in the event there is no surviving spouse. Such assets passing directly to the individuals would not have the protections offered by the trust, but the beneficiaries would have the ability to draw the proceeds out over the 10-year period, rather than having the proceeds sit in the retirement plan until the tenth year, at which time the entire balance would be distributed and taxed. Assets passing directly to such individual beneficiaries will be taxed at their personal income tax rate, which is much lower than the income tax rate for trusts and estates.
For those plan participants who would like to continue to have their trust designated as the beneficiary (or contingent beneficiary) of their IRA or other plan(s), they may consider amending their trust from a conduit trust to an accumulation trust. Unlike a conduit trust, an accumulation trust does not require the trustee to distribute required minimum distributions to the beneficiary based upon the beneficiary’s life expectancy. An accumulation trust allows the trustee to accumulate and hold the plan distributions inside the trust, even after the required 10-year withdrawal period if necessary. This could allow the plan assets to be protected against the legal problems or financial irresponsibility of the beneficiary. However, any such tax deferred assets held in the trust would be subject to an income tax rate which is much higher than the tax rate the beneficiary would have paid had the funds been distributed to him or her. Therefore, while an accumulation trust can provide protection of the assets for the beneficiary, there is a negative income tax consequence to holding the assets in the trust.
I should mention that even if a trust is amended to convert it from a conduit trust to an accumulation trust as described in the previous paragraph, a beneficiary’s circumstances may change during their lifetime thereby qualifying them as an “eligible designated beneficiary” under the new law. As discussed above, even under the new law, eligible designated beneficiaries retain the ability to stretch receipt of an IRA over their lifetime, in which case a conduit trust may have been the better option for them. Therefore, for those individuals who decide to continue to have their trust designated as the beneficiary (or contingent beneficiary) of their IRA or other plan(s), they may also consider amending their trust to authorize the trustee (or another person known as a trust protector) to make future amendments to the trust in order to change the provisions of the trust from an accumulation trust to a conduit trust, or vice versa, depending upon which is more suitable for a beneficiary at that time.
The new SECURE Act will affect everyone’s investment planning and estate planning differently. It is recommend that any participant of an IRA or other defined contribution plan consult with their investment advisor and attorney as soon as possible in order to determine what revisions or actions may be required. This action may involve amending the trust, and/or revising beneficiary designation forms. Depending upon their age and circumstances, some plan participants may also choose to explore the possibility of converting their traditional IRAs to Roth IRAs. Your financial advisor may have other suggestions on these matters.
Please contact Attorney Stephen Kosa if you would like to schedule a time to discuss your particular circumstances, review your trust and estate plan, and assess your best options in light of the passage of this new law.