Wealth management experts encourage people to put money aside for retirement. This works, as it allows you to take advantage of tax-deferred growth if you make contributions to employer-sponsored retirement plans or IRAs. By the end of your career, sizable wealth can be generated within your qualified accounts.
When it comes to leaving your retirement assets to your loved ones, you have two options:
1) either designate them as beneficiaries outright, or
2) designate a trust as a beneficiary. Option one provides the designated beneficiaries with immediate access upon death without any strings attached. Option two typically uses either a revocable trust or a specific stand-alone IRA inheritance trust as the designated beneficiary. The advantages of option two are control, asset growth, deferred income taxes and asset protection because the trust dictates how and when the money is distributed over time.
Now that the SECURE Act has been passed, does your beneficiary designation strategy change? The answer is: Maybe. The SECURE Act altered the timeframe in which a beneﬁciary of a tax deferred plan such as an IRA must take withdrawals.
How the SECURE Act impacts required minimum distributions
The purpose of the SECURE Act was to improve retirement security for Americans. However, this Act also took away the ability of those who would have inherited IRAs or other tax deferred accounts to collect lifetime distributions. Before the passing of this Act, beneficiaries could “stretch” the collection of distributions over the course of their life expectancy and potentially well beyond if an IRA inheritance trust was incorporated into the plan. Post the SECURE Act, the majority of the beneficiaries are required to withdraw their balance within a 10-year period (the “10-year rule”) thereby limiting the “stretch.” The 10-year rule dramatically accelerates the income taxes due and eliminates the profound compounding of the value of the assets that could have occurred in a multi-generational IRA inheritance trust.
Exceptions to the 10-year rule
As with any general rule, there are several exceptions to SECURE Act regulations. Eligible designated beneficiaries (“EDBs”) are not governed by the 10-year rule. Distributions for EDBs can still be stretched out over the EDB’s lifetime.
A surviving spouse is the most common EDB. Other examples of EDBs are a disabled beneficiary or a minor child. Distributions for a disabled beneficiary can still be stretched out over their lifetimes. In the case of minor beneficiaries, the 10-year rule does not start to run until the child reaches the age of eighteen thereby providing a limited stretch.
Conduit vs. Accumulation IRA Inheritance Trusts
In the past, people commonly used conduit and accumulation IRA inheritance trusts to avoid accelerated income tax payments. This was done by extending IRA payments over the beneficiary’s life expectancy. However, for this to be possible, the trust was required to qualify as a see-through trust under the Internal Revenue Code.
The main distinction between conduit and accumulation trusts is whether the income tax payable on the distributions is the responsibility of the trust itself or the beneficiary. For instance, with the conduit trust, it is the duty of the beneficiary to pay income taxes on the distributions. Even after the SECURE Act, this requirement is still in play.
On the other hand, accumulation trusts provided trustees with discretion when it comes to handling the distribution of inherited IRAs. This also protected assets from outside creditors and eased the IRA owner’s concern of quick asset depletion. However, accumulation trusts could trigger additional taxation if trust income was retained in the trust.
IRA Inheritance Trusts for blended families
The SECURE Act has also changed how IRAs work with blended families. For instance, there can be situations when a spouse wants to provide for their children from the first marriage. When that happens, the spouse can leave his IRA to a conduit trust. This will benefit the surviving spouse initially, and they will receive distributions from the IRA based on their life expectancy. The children will be named remainder beneficiaries of the conduit trust. When the spouse dies, the assets will then be passed on to the children as stated by the trust. The children will then be subject to the 10-year rule unless they too have EDB status.
This is an elegant solution because it accomplishes two planning objectives and solves a classic dilemma in blended family situations. First, their surviving spouse is protected while they are alive by providing them with an income stream. Second, blood lines are protected because the IRA Inheritance Trust will prevent their surviving spouse from changing beneficiary designations upon their death to someone other than the children of the spouse who owned the account.
Why Trust Planning is Crucial
Trust planning for retirement assets is still an eﬀective tool even under the SECURE Act. If you want to leave retirement assets to a trust, it is important to determine how to make this strategy work. You must balance the need for control and asset protection with the need to minimize your tax exposure.
As with any new law that changes the playing field, it is important to review your estate plan and beneficiary designations with your estate planning attorney to help ensure that its outcome is consistent with your goals.
If you would like more information about estate planning, consider attending one of our Estate Planning Webinars or Workshops. These are free and answer all of the questions that you have about the process of estate planning. You can also call us at 877-585-1885 or send an email to firstname.lastname@example.org.
Christopher E. Botti,
Esq., Certified Specialist in Estate Planning, Trust and Probate Law