THE SECURE ACT: WHAT IT MEANS FOR YOUR BENEFICIARIES

The SECURE Act (“Setting Every Community Up for Retirement Enhancement Act of 2019”) took effect on January 1, 2020.  While the Act makes numerous changes to retirement plans, we will focus on how the Act affects the timing of payments to your beneficiaries after your death.  The Act does not affect payments to your surviving spouse if he or she is named as beneficiary.

The main change under the Act is that, if your beneficiary would have been allowed to withdraw payments annually over his or her life expectancy after your death, now, with certain exceptions, your plan will need to be withdrawn by the beneficiary within ten years after your death (or your remaining life expectancy, if longer and you were in pay status at your death).  The Act applies to plan participants dying in 2020 or later.  However, it also applies to inherited IRAs where the beneficiary dies in 2020 or later but prior to the end of his or her life expectancy.  In that case, the subsequent beneficiary will have only ten more years to take out the balance of the account.

Under this ten-year rule, there are no required annual distributions – the requirement is that the entire plan be distributed within ten years. While this may allow for income tax deferral until the tenth year, providing some tax planning options, it will accelerate the payment of income taxes in most cases, and may push beneficiaries into higher income tax brackets since larger distributions are taken over a shorter time period.  Note that Roth IRAs are also subject to the Act but will not have any income tax ramifications.  Clients who are in lower income tax brackets than their beneficiaries and have sufficient funds may consider paying the tax now and converting their plans to Roth IRAs.  Clients may also wish to consider taking out life insurance to make up for the early payment of income tax.

There are exceptions which will allow certain beneficiaries (known as “eligible designated beneficiaries”) to receive annual payments (“required minimum distributions”) over their life expectancy:  surviving spouse; a disabled or chronically ill beneficiary at the time of your death (within the definition under federal law); and a beneficiary who is older than you or up to 10 years younger than you.  In addition, your minor child may take payments annually until age of majority but then must take the balance within ten more years. The minor child exception applies only to your own minor children (not a grandchild – even if the parent is not living).  Age of majority may be later than 18 years of age if the child is still in school.

Many clients have named a trust as beneficiary of a retirement plan.  This allows the trustee to have control over the plan where the client does not wish to leave the plan directly to the beneficiary.  Under prior law, a properly drafted “see-through” trust allowed the trustee of the trust to withdraw payments over the trust beneficiary’s life expectancy.  For participants dying in 2020 or later, these trusts will now have to withdraw the entire retirement account within ten years (with certain exceptions discussed below).  There are two types of see-through trusts: “conduit” trusts and “accumulation” trusts.  (Trusts which do not qualify as see-through trusts have to withdraw the entire retirement account within five years.)

With a conduit trust, any amount withdrawn by the trustee is required to be paid out to the beneficiary.  If this requirement is met, then we do not need to look further at who will receive the trust assets after the beneficiary’s death (e.g., a charity or the beneficiary’s estate).  Conduit trusts were popular where there were young beneficiaries since the retirement plan could grow over the beneficiary’s lifetime and only the minimum distributions (or more in the trustee’s discretion) needed to be withdrawn and paid out.  The beneficiary could also direct how the trust assets pass at his or her death (a “testamentary power of appointment”).  Under the Act, the retirement account will now have to be paid out to the trust beneficiary within ten years (with certain exceptions discussed below).  Many clients will decide that it is simpler to just name the beneficiary directly and not use a conduit trust where the retirement plan is the main asset.  Other clients who strongly desire that a trust last for the beneficiary’s lifetime (e.g., for management or creditor protection) will decide that a conduit trust is no longer a good choice.

The alternative type of see-through trust is an “accumulation” trust.  An accumulation trust gives the trustee discretion whether to pay out or retain any withdrawals from the plan within the trust.  Amounts can be distributed to multiple beneficiaries in order to spread the tax burden.  However, if a withdrawal from the plan is accumulated within the trust and not distributed, then it is taxed at the top income tax rate starting at around $13,000.  A downside to these types of trusts is that the beneficiary cannot be given a broad power of appointment at death (e.g., leaving the plan to anyone he or she wishes).  Clients may wish to change their conduit trusts to accumulation trusts to provide more flexibility to accumulate or distribute to a beneficiary.

A trust for an “eligible designated beneficiary” will qualify for withdrawals to be made over the beneficiary’s life expectancy where the trust is a conduit trust (or in the case of a disabled or chronically ill beneficiary, it may be an accumulation trust if no payments can be made to anyone else prior to the beneficiary’s death).

For clients who are charitably inclined, a “charitable remainder trust” can also be drafted so that payments are made to a beneficiary over his or her lifetime, with the remainder paid to charity (including a foundation).  This trust will receive the retirement plan within five years but is not subject to any tax.  The payments made to the beneficiary each year will be subject to income tax.

Note that, under prior law, not all beneficiaries could take withdrawals over life expectancy (e.g., if you named your estate or a charity, or, as mentioned above, a trust not drafted as a see-through trust).  Those plans were required to be withdrawn within five years after your death (or your remaining life expectancy, if longer and you were in pay status at your death).  The rules have not changed for these beneficiaries.

The bottom line is that Congress actually simplified the minimum distribution rules somewhat but eliminated the “stretch IRA” in most cases.  If you named a trust as a beneficiary of your account, the new rules may result in an accelerated distribution from the trust, so you should review the terms to make sure that the plan still meets your objectives.  For more information, please contact a BW Trusts & Estates attorney.

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