The SECURE Act brings sweeping changes to the estate planning landscape.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law by President Trump on December 22, 2019. It will have a far-reaching effect on owners of IRAs and participants in tax-qualified retirement plans. SECURE includes substantial changes to the post-death distribution rules for 401(k) plans, 403(b) annuities, and IRAs. A notable change is the increase in the beginning date for Required Minimum Distributions (RMD) from age 70 ½ to age 72, i.e., there will be no ‘required beginning dates’ for 2021.
Much more significantly, SECURE eliminates the ‘stretch’ provision for IRAs inherited by most nonspouse beneficiaries. Under the prior rules, if a nonspouse IRA beneficiary (e.g., child or grandchild) was named, the beneficiary could take distributions from the inherited IRA over their life expectancy. For example, a 25-year old who inherits her grandmother’s $1 million IRA would be allowed to stretch the distribution (and accordingly, the taxes) over 58.2 years.
The 54th Annual Heckerling Institute on Estate Planning gathered over 3,500 of the nation’s top estate planning professionals in Florida. The interaction of the SECURE Act and estate planning was the primary focus. Kal Goren, estate planning partner at Miller Canfield, relayed that his “firm viewed this as being so significant that they issued an ‘e-blast’ to clients about the wide-reaching provisions of SECURE.”
SECURE eliminates the stretch provision for most nonspouse beneficiaries and mandates that IRA distributions (for both traditional IRAs and Roth) must be completed within ten years, i.e., by December 31 of the year that contains the 10th anniversary of the date of death. Only ‘eligible designated beneficiaries’ may continue to use the stretch; all others must take distributions by the end of ten years following the death of the account owner – potentially 11 taxable years for the beneficiary. For purposes of the SECURE Act, an eligible designated beneficiary is:
1. The surviving spouse of the employee or IRA owner
2. A disabled individual
3. A chronically ill individual
4. An individual who is not the surviving spouse, a minor child, disabled or chronically ill and is not more than ten years younger than the employee or IRA owner, or
5. A child of the employee or IRA owner who has not reached the age of majority. When the child reaches the age of majority, the 10-year rule applies, beginning with the year after the child reaches the age of majority. This rule only applies to the child of the participant, not to the grandchildren or any other child.
Thus, adult children and grandchildren over the age of majority, as well as any other individuals who do not fit into the list of exceptions, would be required to take distributions within the ten years.
Trust. SECURE clearly modifies the use of individual beneficiaries and, in many cases, utilization of a trust as the beneficiary. Existing revocable trusts will need to be modified to accommodate SECURE. Bill Beseth of Tucker Ellis indicated that the firm sees wider use of trusts with SECURE: “By and large, and prior to the SECURE ACT, the most common type of trust to name as an IRA beneficiary was a conduit trust. Now, in the post-SECURE Act world, each client’s situation requires a more thorough analysis to determine if a trust as a beneficiary is the preferable option and, if so, whether an accumulation or conduit trust best serves the outcome the client most desires.”
There are a number of issues associated with using a trust as an IRA designated beneficiary:
1. See-through provisions. In order for a trust to be a designated beneficiary, there are four mandates:
a. The trust must be considered valid and legal under state law, which typically means the creation of the trust document must be witnessed and notarized, and the “conduit feature” must come into effect immediately upon the participant’s death.
b. The trust must become irrevocable upon the plan owner’s death, meaning that the listed beneficiaries can be changed up to the point where the IRA owner passes away, but not after-unless they were to disclaim their interest as a beneficiary within nine months of the plan owner’s death.
c. All beneficiaries must be individuals, easily identifiable, and legally named, and all distributions from the trust must be paid to the individual beneficiary.
d. Documentation of the see-through trust must be provided to the custodian of the IRA by October 31 of the year following the IRA owner’s death. The regulations governing the trust and how it relates to the distribution of the IRA are part of 26 Code of Federal Regulations Section 1.401(a)(9).
Accordingly, a Revocable Living Trust (RLT) that is intended to be a “designated beneficiary” would have to accommodate these four rules, which should not present significant drafting issues.
2. Asset protection. After the Clark v. Rameker U.S. Supreme Court case, assets in an inherited IRA for a nonspouse beneficiary are subject to the claims of the creditors of the beneficiary unless an exemption applies under the beneficiary’s state law or the Federal exemption is elected by the debtor on filing in Bankruptcy. In Clark, the daughter and son-in-law of a deceased IRA holder suffered a business failure, and the IRA assets were accessible by the couple’s creditors. Any RLT as a designated beneficiary would logically have a spendthrift clause to protect assets. Goren of Miller Canfield suggests, “A spendthrift trust should work while the assets remain in the trust and there is limited access to the principal of the trust. Absent state law that protects an ‘inherited IRA’ from the beneficiary’s creditors (e.g., Florida, Alaska, Arizona, Delaware, Idaho, Maryland, Minnesota, Mississippi, Missouri, North Carolina, North Dakota, Ohio, Oregon, Rhode Island, South Carolina, Texas, Washington, West Virginia, and Wyoming) where the beneficiary is the sole trustee and sole beneficiary has been held not to protect the IRA from the beneficiary’s creditors and warrants further attention.”
3. Allocation of IRA assets. With the new ten-year rule in effect, it may be beneficial to allow the Trustee to allocate assets amongst beneficiaries. These allocations may include:
a. An allocation amongst human beneficiaries of Roth and traditional IRA assets. For example, allocating Roth to high-bracket beneficiaries and traditional IRA assets to lower-bracket beneficiaries, with the directive to equalize after-tax distributions.
b. An allocation of assets amongst charity and human beneficiaries. For example, allocating traditional IRAs to fulfill a charitable bequest and allocating other trust assets to human beneficiaries.
An allocation clause could run into equalization issues where a beneficiary might object to receiving pre-tax over after-tax assets unless the assets are “grossed-up.” This clause will undoubtedly be deliberated by the estate planning wizards, likely over libations.
4. Modifying the timing of distributions. The ten-year rule mandates complete distribution within ten years of the Participant’s death. Each year has possible different income tax outcomes for a beneficiary. The trust should allow the Trustee to distribute in accordance with the beneficiary’s tax situation. This might include:
a. Timing bigger distributions in accordance with charitable bequests, like a Donor Advised Fund (DAF) or charitable trust. A beneficiary may garner significant tax benefit by ‘bunching’ charitable contributions (e.g., making ten years’ worth of charitable donations in one year to a DAF) and offsetting that with an IRA distribution.
b. Timing distributions to coordinate with a beneficiary’s (or beneficiary’s spouse’s) income, expense, or loss from a pass-through entity. Under the Tax Cuts and Jobs Act (TCJA), there are notable provisions to pass-through entities (Sub-S, LLC, sole proprietorships, and others), including:
i. Full-expensing of equipment. If a pass-through has substantial asset purchases, those can be fully expensed, and the purchase used to offset an IRA distribution.
ii. Excess loss limitation. The TCJA provides limitation of excess losses from a pass-through entity. Depending on the facts and circumstances, an IRA distribution may allow some offset of the limited losses.
iii. Interfacing the Qualified Business Income (QBI) deduction to distributions. Pass-through entity (basically, any entity except a C-corp.) owners can take advantage of a deduction for pass-through income. Timing an inherited IRA distribution to utilize the QBI deduction can be advantageous if the beneficiary is near a threshold for QBI for a Specified Service Trade or business (currently $326,600 for married filing joint and $163,300 for other filers).
5. Giving the Trustee the ability to disclaimer the benefit. Given the ten-year rule accelerates taxes to a beneficiary, another logical power to give the Trustee would be the power to disclaim the benefits of an IRA to the next generation. Thus, a parent in a high tax bracket may make a partial or full disclaimer so long as the recipient is their child(ren). The Trustee should make the disclaimer with the knowledge/consent of the beneficiary. The Trustee disclaimer would have to follow the normal disclaimer rules:
a. The beneficiary must provide an irrevocable and unqualified refusal to accept the assets.
b. The refusal must be in writing.
c. The document must be submitted to the retirement account custodian at the later of the following times:
i. Nine months after the retirement account owner dies.
ii. Nine months after the beneficiary attains age 21 if he or she is not 21 when the retirement account owner dies.
d. The beneficiary must not have accepted any of the inherited assets prior to the disclaimer.
e. The assets must pass to the successor beneficiary without any direction on the part of the person making the disclaimer.
Goren indicates that he has recommended disclaimers for years. “We find that the issue with the disclaimer isn’t whether they are a good idea, it’s getting the IRA custodians to accept the disclaimers. The custodians can’t seem to fit the flexibility into their computer screens and always want to err on the side of simplicity. It’s a simple matter of why people use financial advisors, to get these kinds of things done properly.”
6. Coordinating with other bequests. Logically, IRA distributions should be coordinated with other trust bequests. Many trusts follow a two-or three-way ‘sprinkle,’ where assets might be distributed at ages 25, 30 and 35 with a maximum age of 40. Using a 10-year payout with a 45-year old child will disregard this provision. The trust must distinguish IRA assets from other assets or allow for the distribution of the IRA as an “inherited IRA” to the trust beneficiary.
Bottom line. IRA owners will now need to rethink their estate plans and may want to modify their beneficiary designation and revocable trust provisions to provide maximum benefit to beneficiaries as a result of the major change caused by the SECURE Act.
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