- Revision of beneficiary designation forms.
- Revision of wills and trusts that include provisions creating so-called conduit trusts that had been intended to hold IRAs and preserve the stretch IRA benefits while the IRA plan holder is still alive.
- Possible modification of existing conduit trusts (defined below) that are not modified before the plan owner’s death to address how the SECURE Act might undermine the intent of that trust when the will or trust providing for it was created.
- Complete rethinking and restructuring of the planning for the IRA account. This might include designating a charity as a beneficiary of the account and perhaps using life insurance or other planning steps to address the economic value of what is given to charity. Another possible alternative is paying the IRA balance to a Charitable Remainder Trust (“CRT”) on death that will stretch out the distributions to the beneficiary of the CRT over that beneficiary’s lifetime under the CRT rules. That plan might be paired with a life insurance trust to replace the assets ultimate passing to charity under the CRT requirements.
- Beneficiary designations for IRA and other plans. For example, if the taxpayer had relied on the income tax benefits of the stretch IRA rules to dissuade an otherwise imprudent beneficiary not to withdraw, spend, or worse squander, plan assets, that assumption should be reconsidered. It might not be preferable to name an accumulation trust as the beneficiary of the IRA so distributions from the IRA as well as the plan balance can be protected from the beneficiary’s fiscal irresponsibility. The plan owner might consider the negative income tax consequences a worthwhile price to pay to protect assets that the beneficiary might otherwise withdraw and spend to soon. If the plan owner does not feel that cost is worthwhile then other options might need to be considered, e.g. the CRT option mentioned.
- Trusts named as beneficiary of plan assets. There are two types of trusts that can be used as beneficiaries of IRA assets: an accumulation trust and a conduit trust. The accumulation trust, as its name implies, can accumulate plan distributions inside the trust. The second is a conduit trust that passes IRA distributions through to the beneficiary. If the trust was a conduit trust designed to take advantage of the stretch rules that plan balance may have to be distributed in 10-years thereby eliminating the income tax benefit, but worse, exposing plan assets to the possible imprudence of the beneficiary and potentially creditors or divorcing spouses of the beneficiary. In some cases the plan owner might prefer to instead name an accumulation trust to hold plan assets.
- Surviving spouses.
- Chronically ill heirs as defined in Code Section 72(m)(7).
- Disabled heirs as defined in Code Section 7702B(c)(2) with certain modifications.
- Many states permit a non-judicial modification of a trust by agreement of those involved but if the plan holder whose will or trust is involve is deceased that may not be a viable option.
- Courts might reform an existing conduit trust into an accumulation trust if it can be demonstrated that the SECURE Act changed the result that the testator or trustor had at the time of executing the instrument creating the conduit trust.
SECURE Act’s New IRA Rules: You Might Need To Change Your Estate Plan
Originally posted on Forbes.com
Introduction and Action Steps
The Setting Every Community Up for Retirement Enhancement Act of 2019, called the “SECURE Act” makes significant changes to how IRAs and certain retirement benefits must be treated post-death. Rules Committee Print 116–44 Text of the House Amendment to the Senate Amendment To H.R. 1865, December 16, 2019, the “Further Consolidated Appropriations Act, 2020.”
These changes are so significant every such plan holders should review their wishes and how their estate plans may be affected. This may result in:
Some of these will be explained in more detail below.
What the Secure Act Does to IRAs
While there are many changes affecting a variety of tax laws, the most talked about change of the SECURE Act is the death of the so-called “stretch IRA” for most beneficiaries inheriting IRAs after 2019. For most of those inheriting an IRA after 2019 they will be required to completely withdraw all plan assets within 10 years of the date of death. It would seem that this might enhance tax revenues to the tax authorities as contrasted with the long stretch periods that had previously been available.
No withdrawals have to be made during the 10 year period, but at the end of 10-years from the date of the plan holder’s death the entire balance in the plan must be withdrawn. Under prior law there was a difference in the period over which IRA assets had to be distributed based on whether the plan owner died before or after the RMD. Under the SECURE Act the same rule requiring complete withdrawal by year 10 will apply in all cases (other than for eligible beneficiaries discussed below).
The ramifications of this will be significant for many.
Death of the Stretch
The stretch IRA is a planning technique that permitted an heir to defer IRA distributions over a long period of time, deferring income tax and permitting the IRA balance to compound income tax free. More specifically, Following the death of the IRA owner or plan participant, the retirement benefits passing to a qualified beneficiary, called a “designated beneficiary” are paid over the life of the designated beneficiary. When the designated beneficiary is much younger then the IRA owner, e.g. a grandchild, that deferral or stretch out of payments provided a significant income tax benefit. The Required Minimum Distributions (“RMDs”) are calculated based on life expectancy of the grandchild or other young heir so after the death of the plan owner the plan assets would be paid out over that long life expectancy.
That deferral and the accompanying income tax benefit was also a consideration that made many IRA owners comfortable bequeathing a large IRA balance outright. Other taxpayers sought more protection for larger accounts and had the IRA paid to a special type of trust called a “see-through trust” or “conduit trust” that would flow the RMDs to the beneficiary, thus realizing the stretch, but protecting the balance of the plan for future years. The use of such a trust could thus insulate the large plan balance from the beneficiary’s imprudence if the plan had instead been paid outright. All these assumptions have been changed by the SECURE Act and taxpayers and their advisers should reevaluate:
Exceptions from the 10-Year Rule
There are exceptions from the new 10-year SECURE Act payout rule. Those heirs who meet the definition of a new term, “eligible designated beneficiaries,” are not subject to the 10-year payout rule. SECURE Act Section 401(a)(2). Eligible designated beneficiaries include:
These eligible beneficiaries can withdraw plan assets over their life expectancy.
Minor children are also considered eligible beneficiaries so that the 10-year payout will not apply to them. However, when the minor reaches the age of majority the 10-year rule will apply so that the plan assets will have to be paid out by year 10, age 28.
Revision of Beneficiary Designation Forms
Taxpayers should review their IRA and plan beneficiary designations forms, and if they have professional advisers, involve them in the process, as the decisions for many might be complicated. Some taxpayers may have named a conduit trust as beneficiary and might wish to revise that trust into an accumulation trust to avoid the beneficiary receiving a large lump sum distribution after 10 years. Others may opt to bequeath (or gift while alive) some portion or even all of their IRA outright and instead place assets passing under their will in trust. Then in other situations, the IRA owner might wish the IRA assets to pass into a CRT. If the IRA owner had bequeathed some or all IRAs to grandchildren to maximize the stretch, there will no longer be a benefit to that planning since the assets will have to be paid out over 10 years. These taxpayers might revisit their plan and decide instead to leave the IRA assets to children will obtain the same maximum 10-year deferral (assuming that they are not eligible designated beneficiaries).
All of this should be coordinated with what is done under the will (or revocable trust as the case may be) and as part of a comprehensive reconsideration of the new rules. For example, if an IRA holder’s plan was to bequeath IRA assets to grandchildren and they had a life insurance trust purchase life insurance to benefit children, the entire plan might warrant reconsideration. Perhaps the IRA can be redirected to the children, but then what of the life insurance trust?
If the plan holder is disabled review any power of attorney to see if the agent has the authority to change the beneficiary designation to help revise the plan.
Revision of Wills and Trusts
One revision to consider making to an IRA owner’s will is to perhaps change the conduit trust that had been designed to hold IRAs and distribute the RMDs to the beneficiary as they are paid into a different type of trust called an “accumulation trust.”
But there is another change some IRA owners might want to consider, and that might include an almost complete revamping of their estate plan.
Example: The IRA owner might have had IRA assets held in trust and the remainder of the estate distributed outright without any trust to heirs. The thought might have been that the IRA distributions will be stretched, so why not give the remaining assets outright. Now that the “stretch” is limited to 10-years, the plan owner might consider leaving a conduit trust to hold IRA assets for that 10-year period and then bequeathing the remaining estate into another trust so that those assets can be held longer in the trustee’s discretion. That might amount to a “flip-flop” of the dispositive scheme with all assets previously bequeathed outright now going into trust. The trustee of the non-retirement assets could make discretionary distributions to perhaps approximate what the prior plan might have accomplished.
Example: The IRA owner might revise the beneficiary designation for their plan to designate a CRT as beneficiary. On death the IRA can be paid to the CRT. No current taxable income would be realized. Payments would be made to the intended beneficiary pursuant to the terms of the CRT, but generally with a minimum 5% payout, and each payment would carry out a portion of the income. This might accomplish something approximating the intended deferral before the SECURE Act. There are more complex CRT variants which might be considered.
Example: The IRA owner in the above example might also purchase life insurance on their life to replace the estimated assets going to charity at the end of the CRT which must be at least 10% under the CRT rules. That insurance might be held by an insurance trust. But the IRA owner should consider funding that trust before the 2020 election since if the Democratic proposal of capping annual exclusion gifts at $20,000 per donor is enacted that might inhibit funding the insurance plan. This is similar to a planning concept some had called “a wealth replacement trust” but applied in the new post-SECURE Act context.
Of course if a CRT is added to the plan the costs of creating and administering the plan, and possible life insurance as well, must be considered.
What Can Be Done about Old Conduit Trusts if the IRA Owner Dies Before Changing the Trust Terms?
The reality is that most taxpayers ignore warnings and recommendations from the media and even their own advisers. Few enjoy discussing planning for death, and even fewer the professional fees their advisers will charge to update documents. So it is likely that many taxpayers will not revise their wills and or trusts to modify pre-SECURE Act conduit trusts, e.g. changing them into accumulation trusts to prevent a large lump sum distribution to a beneficiary after 10 years. All may not be lost as even post-death there may be ways to modify the trust and provide a safer result.
What about IRAs Inherited before 2020?
The SECURE Act only applies to retirement plans that are inherited after January 1, 2020 so the complex distribution rules that existed under prior law will continue to apply to many heirs. So when any heir or adviser is considering advice on an inherited IRA or other plan they will first have to determine which set of rules apply.
Change in Age for RMDs to Begin
The SECURE Act increases the age at which retirees must begin taking RMDs from 70½ to 72. This gives an economic nod to longevity. With taxpayers living longer they can now leave assets inside a plan growing tax deferred for a bit longer. Presumably that may help with funding retirement for those plan holders who can afford to wait until 72 for their distributions. Section 114 of the SECURE Act amended Code Section 401(a)(9)(C)(i)(I).
One planning technique might be adversely affected by this extension of RMDs. Plan holders can direct up to $100,000 of IRA funds to be paid directly to charity. This is called a Qualified Charitable Distribution (“QCDs”). That has the effect of a dollar for dollar deduction for charitable contributions for the plan holder. QCDs may now have to wait until the age 72. SECURE Act Section 107(b) provides rules to coordinate the new IRA rules with QCDs.
Contributions Without Age Restriction
Under pre-SECURE Act law contributions to IRAs had to stop at age 70 ½ (the same age at which RMDs had to begin under prior law). If the taxpayer would turn 70 ½ before the end of the tax year, additional contributions to an IRA were not permitted. Under the SECURE Act there are no longer any limits on the age through which contributions can be made. With longevity many people continue working long past the traditional age-65 retirement and this change will give them the flexibility to continue contributing to tax advantages IRAs. SECURE Act Section 107 repealed Code Section 219(d)(1).
More Liberal Withdrawal For Birth and Adoption Costs
The SECURE Act now permits withdrawals of up to $5,000 IRAs and certain other plans to pay expenses for the birth or adoption of a child. Under prior law such a withdrawal could have been subjected to penalties, but no longer. SECURE Act section 113 amending Code Section 72(t)(2). This leniency will be available for distributions from an eligible retirement plan to an individual if made during the 1-year period beginning on the date on which a child of the individual is born or on which the legal adoption by the individual of an eligible adoptee is finalized. An adopted child is one who has not attained age 18 or who is physically or mentally incapable of self-support.
The SECURE Act will have a significant impact on many estate and retirement plans. The implications will vary by taxpayer and could have very different consequences depending on each taxpayer’s goals, assets inside IRAs or plans or outside them. State income tax implications should also be considered. It is also important that taxpayers evaluate options in a holistic manner considering the many ripple effects of both the SECURE Act and changes to the plan.
Martin Shenkman I am an estate planning attorney, author of 42 books, and more than 1,200 articles. I serve on the editorial boards of Trusts & Estates Magazine, CCH (Wolters Kluwer) Professional Advisory Board, CPA Magazine, and the CPA Journal. I’m active in many charitable and community causes and organizations and spend two months/year traveling the country educating professional advisers on planning for clients with chronic illness and raising both awareness and funds for many charities helping people face the challenges of chronic illness. I serve on the board of the American Brain Foundation Board, and its Strategic Planning Committee, and Investment Committee. I hold a BS degree in accounting and economics from Wharton School, an MBA in tax and finance from the University of Michigan, and a law degree from Fordham University School of Law.
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