Your CPA And Estate Planner’s Guide To The New IRA And Pension Inheritance Rules
I am a tax lawyer and board certified estate planning lawyer, and the lead author of the book entitled Planning for Ownership and Inheritance of Pension and IRA Accounts, which is now being rewritten.
The new SECURE Act that was signed into law on December 20, 2019 provided a significant and mostly taxpayer unfriendly overhaul of the rules that apply to require IRAs and pension accounts to be paid out after the death of a Plan Participant. While the age for beginning to take out distributions was increased from 701/2 to 72, individuals with large IRAs that eventually are passed to or for descendants or other non-spouses will usually now have to pay out within 10 years of the account owner’s death, instead of over the life expectancy of individual or trust beneficiaries. This significantly reduces what the net after tax inheritance will be for many families, but may help charities, which can receive distributions income tax free.
The rules are very complicated, but important to plan for, so I have tried to write this article to be understandable by laymen, and also tax professionals.
IRA and pension account owners who leave a surviving spouse have most, but not all, of the same “stretch IRA” options as they had before, which include allowing the surviving spouse to roll the IRA over and not take distributions until after he or she reaches age 72, allowing the surviving spouse to treat the IRA as an “inherited IRA” and take distributions ratably over his or her lifetime with no 10% excise tax for distributions before the beneficiary spouse reaches age 59 , or having the payment go to a “See-Through Conduit Trust,” where any distributions coming out of the IRA or Pension have to be paid without delay to the spouse, but with whatever remains in the IRA on the surviving spouses death being protected for the descendants or other intended beneficiaries of the first dying spouse who originally owned the account.
The payout schedule is slower, and thus more advantageous, if the spouse uses the rollover choice, and that is the only choice that normally allows the spouse to not take distributions until the calendar year after he or she has reached age 72.
Under prior law the benefits could be payable to a “See Through Accumulation Trust” and come out over the life expectancy of the surviving spouse, while being accumulated for possible later inheritance by the chosen beneficiaries of the plan participant, with the trustee being able to make payments for the benefit of beneficiaries other than the surviving spouse.
Thousands of people have these spousal accumulation trusts in place and do not yet realize that a 10 year distribution rule will now apply when the first spouse dies after 2019. Many of these trusts will be converted into conduit trusts, roll over IRAs or charitable remainder trust IRAs, as discussed below.
A surviving spouse can also still elect to annuitize the IRA or pension account by having the resulting IRA purchase an annuity contract that would make equal lifetime payments to the spouse, and guarantee a stream of payments for his or her entire lifetime, without the economic risk of ever running out of monies, but beware of the economic results that can occur when sales commissions have to be paid, and what inflation does to the value of a fixed dollar payment amount over time.
Another possible alternative is to allow the spouse to use the IRA as a rollover or as an inherited IRA, but to have a Marital Asset Protection System (”MAPS”) arrangement whereby the spouse is contractually bound to save the IRA and only use it, and the payments received, as explicitly permitted in the agreement. I can provide more information on this if requested. You can just put the word “Map” in the re line of an e-mail to firstname.lastname@example.org.
We do not know for certain whether such an agreement would have a detrimental impact on such an IRA, and to our knowledge no-one has ever requested an IRS ruling on this issue or had one of these challenged.
Another alternative that will be very popular among affluent charitable taxpayers is the Marital Income Charitable Remainder Trust (”MARI-CRUT”), which can be funded upon the death of the deceased Plan Participant and drafted to provide an annual payment to the surviving spouse that will be based upon a percentage of the value of the IRA and any other assets of the Charitable Remainder Trust each year, as determined under IRS tables which require that the initial net present value of the arrangement will be based upon no more than 90% of the expected value passing to the surviving spouse, and an actuarially calculated initial probability that 0% of the expected value will pass to charity after the death of the surviving spouse, or a term of up to 20 years. The remainder charity can be a family foundation formed just before the end of the term of years interest.
The annual payment that releases taxable income from the IRA from the MARI-CRUT based upon a 20 year guaranteed pay out starting in February of 2020 would be approximately 11% per year in the value of the trust assets, and the payments can be sprinkled out among the surviving spouse and other beneficiaries, or paid to long term trusts for the spouse and beneficiaries. The income from the payment will be paid by the person or trust that receives it, and can therefore be directed to lower bracket taxpayers depending on what works best from a tax planning standpoint.
Taxpayers who know that they want to benefit charity in their planning can change from what they now have to a MARI-CRUT in order to optimize tax and family planning results.
Those who consider a MARI-CRUT may also be interested in a more complicated variety thereof known as a Flip NIMCRUT which is described in other articles and has not yet been given clearance by the top experts as to how it can work for IRA planning. We are studying this and plan to use and write about Flip NIMCRUTs in the near future.
Married taxpayers with large IRA and pension accounts will need to look at their expected tax brackets, needs, and objectives to decide which of the above arrangements will work best.
Some taxpayers will use a combination of arrangements, such as by putting one-third of an IRA into an Accumulation Trust, one-third into a Conduit Trust and one-third into a Charitable Remainder Trust.
There is much to consider besides the above, because after the death of the surviving spouse the payout to or for children or others will normally have to come out approximately 10 to 11 years after the death of the surviving spouse if things are set up correctly, or approximately 5 to 6 years if things are not set up correctly.
When the surviving spouse dies, or there is no surviving spouse, there are special arrangements that are available to give a more favorable payout arrangement for the following categories of beneficiaries if the applicable rules are followed:
- Minor children of the deceased IRA owner may have small payments required until reaching the age of majority, and then a 10 year rule may apply. The age of majority may be extended by staying in school through up to age 26, and hopefully regulations will be forthcoming to explain what this means.
- Trusts can be established and funded directly from IRAs on the participant’s death to benefit someone who is severely disabled or chronically ill on the date of death, and a lifetime payout can apply for so long as the person stays disabled or chronically ill. These trusts may protect the assets from Medicaid depending upon where the person resides. Some people will be moved now in anticipation of the death of a parent to prevent Medicaid disqualification on death.
- Beneficiaries who are not more than 10 years younger than the deceased participant can also qualify for a lifetime payout.
- Those who survive a participant who was over age 72 when he or she died may be able to take withdrawals over the life expectancy of the over 72-year-old, but the law is not clear on this so we will probably need to wait for regulations or pronouncements from the IRS before this is clearly understood.
- Charities pay no income tax on the direct receipt of IRA and pension account assets when properly arranged. Taxpayers over age 70 continue to have the right to cause up to $100,000 a year to pass from their IRA directly to the charity of their choice to allow charity to receive the payment tax free.
Consider the TEA POT Trust.
Under the prior law most well advised affluent families divided their IRA accounts into separate equal shares for their children, knowing that these would come out with minimum tax impact by using a lifetime payout trust arrangement.
Now it would make more sense to leave the IRA and pension accounts for the lower tax bracket beneficiaries and other assets to the higher bracket beneficiaries, but parents normally want to be fair and leave assets equally to the children and their descendants.
To take this into account the TEA POT system consists of one trust that receives IRA and pension account ownership and has to withdraw all balances and will distribute them to the lower bracket beneficiaries, and a second trust that can be used to “even things up” when it is known how much and at what tax rates the taxable trust income has been distributed.
TEA POT stands for Tax Effective Allocation Pot Trust. A Pot Trust is a trust that holds assets “in the pot” for several beneficiaries and allows for the trustee to distribute the income and principal like a common pot of stew (or lobster bisque for the affluent) based upon need. We call the trust that receives the IRA and pension accounts the “Taxable Trust” and the trust that receives the non taxable “even up” investments the Equalization Trust. A separate article on TEA POT Trusts can be received by e-mailing me at email@example.com, and a comic video about TEA POT Trusts can be seen on YouTube.
This article just scratches the surface on the IRA and Pension rules that apply upon death, and is no substitute for good professional advice from a CPA or tax lawyer who has significant experience and expertise in this area. We are updating our book entitled Planning for Ownership and Inheritance of Pension and IRA Accounts and will have it on Amazon soon. For a promotional discount code you can contact me at agassman@gassmanpacom.