We reported on the SECURE Act when it was enacted at the end of 2019. (You can read about the rules it changed here.) Since then, we and other attorneys have been parsing it and learning a lot more about how its changes work and how they may affect clients. Here’s some of our new learning:
1. Estates in Progress May Want to Disclaim
Except for eligible beneficiaries (spouses, minor children, and disabled or chronically ill individuals), those inheriting IRAs from decedents dying this year and in the future will have to withdraw and pay taxes on the inherited accounts within 10 years from the year of the original owners death. Those who inherited IRAs from people dying before this year can continue to “stretch” out the distributions through their own lifetimes.
A planning opportunity is available for the estates of people who died during 2019, but within the last nine months. Those inheriting large IRAs have the option of disclaiming them and allowing the ultimate inheritors to stretch their withdrawals. A disclaimer is an option for someone entitled to property from an estate to elect for the property disclaimed to be treated as if the person inheriting it had actually died before the decedent.
An example can explain how this could work. Let’s assume that Robert died on September 1, 2019, leaving a $1 million IRA to his wife, Stacy. The contingent beneficiaries are their three children. Stacy is in her 80s and well off. She doesn’t expect ever to need the IRA. If she does nothing, she will inherit it and can make withdrawals based on her life expectancy. At her death, it will pass to their three children, but since she is still alive in 2020, they will be subject to the new 10-year withdrawal rule. Since they’re all still working, the withdrawals would be subject to a high tax rate.
Stacy could choose to disclaim the IRA (or a portion of it) so that it passes directly to her three children. They then could stretch the withdrawals over their life expectancies, postponing the bulk of their withdrawals until they are older and presumably retired and subject to lower tax brackets. Stacy has to execute her disclaimer by March 31st so that it’s within nine months of Robert’s death. The window for this option will continue to narrow until it closes completely on October 1, 2020.
2. You May Want to Amend Your Conduit Trust
Your estate plan may have been designed to have your retirement plans to pass into trust for the benefit of your spouse, your children, or others. If your spouse is the only beneficiary, your trust is fine because the SECURE Act did not change any of the rules for spouses inheriting IRAs. But the rules did change for just about everyone else in a way that could impact how the trust would work.
The easiest way to draft a trust that works to hold inherited retirement plan assets is to provide that annual required minimum distributions be distributed out to the beneficiaries each year. This is a so-called “conduit” trust. Under the rules that apply to anyone who died before this year, those withdrawals could be relatively small. A 51-year-old, for instance, must only withdraw 3%, hopefully less than the tax-free investment growth on the inherited IRA. That’s all that must be distributed out from the conduit trust.
In contrast, under the new rules, the IRA must be completely withdrawn by the end of the 10th year after the owner’s death and if it’s held by a conduit trust, completely distributed to the trust beneficiaries. If you created the trust to protect assets in the event of divorce or bankruptcy, or simply so they will be professionally managed, the new rules could well undermine the purpose of the trust. It’s worth reviewing the situation with your attorney.
3. You Also May Need to Amend Your Special Needs Trust
Special needs trusts, unlike most other trusts, are usually drafted as so-called “accumulation” trusts if they are meant to hold inherited IRAs. Unlike conduit trusts, they do not require that the RMDs be distributed out because doing so could undermine eligibility for public benefits the disabled beneficiary may be receiving. Instead, they can be retained by the trust and distributed as the trustees deem appropriate. They’re a bit more difficult to draft so, until now, most drafters have opted for conduit trusts where the limited requirement to distribute the RMDs is not a problem.
But special needs trusts could present another issue under the new rules. Disabled beneficiaries are deemed “eligible designated beneficiaries” and fall under an exception that permits them to continue to stretch withdrawals under the old inherited IRA age-based schedule. This is good news. But the trust will only qualify for this treatment if the disabled individual is the only beneficiary of the trust during his or her life. If the trust also permits distributions to a spouse or children, it won’t qualify and the IRA will have to be completely withdrawn under the 10-year rule. One of the problems with the 10-year rule for accumulation trusts, as opposed to conduit trusts, is that the withdrawn funds if held by the trust will pay taxes at the trust tax rates, which are much higher than individual tax rates in most cases. As a result, if your estate plan includes a special needs trust that could be a beneficiary of your retirement plan assets, it’s important that you have the trust reviewed.