The SECURE Act was passed in late 2019 and affects IRAs and 401(k)s (included in this description are other qualified retirement plans) as of January 1, 2020. Many of our clients have asked how this could affect their planning. As expected, the law is not simple and there is not one universal approach. This article outlines our thoughts and general recommendations regarding the impact of the SECURE Act on planning for our clients.
The SECURE Act eliminates the ability to stretch the distributions from an IRA or 401(k) over the life expectancy of a non-spouse beneficiary and replaces that life expectancy stretch with a requirement that the beneficiary must take full distribution of an IRA or 401(k) by the tenth (10th) anniversary of the participant’s death (“10 Year Rule”). There are exceptions to the 10 Year Rule for special situations, which will not be discussed here. For purposes of this article, we will assume it is your desire to leave your IRA and 401(k) assets to your children.
Under the new SECURE Act, there are 3 options for naming children as beneficiaries of your IRA and 401(k):
Option 1: Individual is Named as Beneficiary
Option 2: Conduit Trust is Named as Beneficiary
Option 3: Accumulation Trust is Named as Beneficiary
Please review the summary below with respect to each option.
Option 1: Individual is Named as Beneficiary:
- Update Beneficiary Designation Language “BDL” to name individual as beneficiary
- No trust is involved, therefore no trust protections apply
- 10 Year Rule applies, meaning the beneficiary has the following options: o take lump sum immediately – income tax liability accrues immediately
- take distributions over time –income tax liability can be spread out over time
- take no distribution at all until 10th anniversary of participant’s death – income tax liability accrues in year 10 (Note: higher potential for increase in overall tax rate for that year.)
Option 2: Conduit Trust Named as Beneficiary:
- Update “BDL” to name trust as beneficiary
- Trust protections apply so long as funds retained in trust (up to the 10-year period)
- 10 Year Rule Applies, meaning at the end of the 10-year period, the trust must distribute the entire value of the IRA to the trust beneficiary. For example, if the balance of the IRA in year 10 is $400,000, that $400,000 is distributed directly to your child, no matter what age your child is at that time, trust protections do not apply to the $400,000 distribution, and your child bears the income tax liability.
- The conduit trusts are allowed to have non-natural persons as beneficiaries (i.e., charities).
- No changes to your estate planning documents are needed if you desire the results outlined herein.
Option 3: Accumulation Trust Named as Beneficiary:
- Update “BDL” to name trust as beneficiary
- Trust protections apply so long as funds are retained in trust (there is no requirement to distribute from trust within 10-year period)
- 10 Year Rule applies, meaning the Trustee has the following options: o take lump sum immediately – income tax liability accrues immediately to the trust
- take distributions over time – income tax liability can be spread out over time to the trust
- take no distribution at all until 10th anniversary of participant’s death – income tax liability accrues in year 10 to the trust
The difference with the Accumulation Trust is that the Trustee can elect to retain the distributions in trust (i.e., not make those distributions to the beneficiary), then trust protections remain in place with respect to such funds, but the trust bears the income tax liability (usually at a higher income tax bracket than your child). However, the Trustee can elect to distribute some or all of such distribution to your child, which permit the distributed amount to be taxed on your child’s income tax return at your child’s income tax rate, but the trust protections are lost with respect to the distributed amount.
- Allows the Trustee to allocate the income tax burden between the trust and your child in the most tax-advantageous way.
- The accumulation trust cannot name any non-natural persons as beneficiaries (i.e., charities). If a non-natural person is named as a beneficiary, then the 10 Year Rule referenced above is reduced to a 5 Year Rule.
- You must implement changes to your estate planning documents if you desire the results outlined herein.
Prior to the SECURE Act (and in most situations), planning for our clients implemented Option 2: Conduit Trust as Beneficiary for the benefit of their children. While this option remains viable, in our opinion, it is no longer the best option because it does not permit the Trustee to retain distributed IRA and 401(k) funds beyond the 10 Year Rule thus such funds lose all trust protections by year 10. Post-enactment of the SECURE Act, it is our general recommendation to clients that Option 3: Accumulation Trust as Beneficiary be utilized for the benefit of their children as it permits the Trustee to retain distributed IRA and 401(k) funds beyond the 10 Year Rule, thus extending the trust protections over those funds for a longer period of time.
As a reminder, under current law, trust protections include, but are not limited to, the following:
- Creditor Protection – trust assets are protected from your child’s creditors, meaning if your child is sued for liability, trust assets cannot be reached to satisfy that claim for liability
- Segregation from Marriage – trust assets are segregated from marital assets, thus offer far greater protection in case of divorce.
3. Management – Management of trust assets by the Trustee so that another person has decision making authority with respect to those assets until your child reaches the age specified in your estate planning documents, when he or she can become his/her own Trustee
4. Income Tax Flexibility – The Trustee has the power (but is not required) to make distributions of income to your child, as the beneficiary of the trust, in order to take advantage of a child’s lower income tax bracket. As a trust reaches the maximum income tax bracket at $15,000 of income, this allows an opportunity to reduce overall income tax liability by distributing income out of the trust to your child and then that distributed income is taxed at your child’s individual income tax rate. The Trustee can consider other factors to determine whether the reduced income tax liability outweighs the benefits of holding income inside the trust. This is a case by case determination to be made by the Trustee. Example of factors: child has creditor issues, child is not good with money, child is in an unstable marriage.
In the event you determine Option 3: Accumulation Trust as Beneficiary meets your planning goals, we have developed an amendment that can be tailored to your estate plan that will update such plan to align with what we perceive as the most flexible beneficiary designation option available under the SECURE Act. Our fee for such amendment is $345.
This article is intended to be informative but cannot adequately address each client’s unique situation. If you would like a meeting or teleconference to discuss the impact the SECURE Act has on your estate plan, we are happy to coordinate that with you. Time for such a meeting or teleconference will be billed at our normal hourly rates and will be billed in addition to any fee charged for amending your planning.
Please let us know if we can be of any assistance to you in this regard.