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X SECURE Act Can Negatively Affect Estate Plans
Posted on February 10, 2020

SECURE Act Can Negatively Affect Estate Plans

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Scott Roberts, CPA, CLU, Director of Insurance Strategy

 

Most people know by now that the Setting Every Community Up for Retirement Enhancement (“SECURE”) Act – gotta love government acronyms – has some major changes to IRA rules.  One, moving the Required Minimum Distribution (“RMD”) age to 72 from 70 ½, is helpful.  Another, effectively rendering obsolete the “stretch” technique used by many estate plans, is extremely disruptive.  Under the new rules, unless you are a spouse, minor child, disabled beneficiary, chronically ill beneficiary or a beneficiary that is less than 10 years younger than the plan participant, you are required to fully distribute all the assets from an inherited IRA by December 31 of the year that includes the 10th anniversary of the date of death.  And when that minor child reaches the age of majority, the 10-year countdown begins for them too.  In most cases this accelerates and bunches distributions resulting in less tax deferral and, often, higher tax brackets – i.e. higher taxes due sooner.

 

With those basics out of the way, let’s explore how the new rules specifically affect estate planning and what changes may be necessary.  First, it appears that a “minor child” means only the child of the plan participant.  So, with clients having increasingly blended families, absent actual adoption, a stepchild would not qualify.  Nor would a grandchild or more remote beneficiary qualify.  Each would be required to fully distribute an inherited IRA within 10 years.

 

Also problematic are many trusts, designed to be the beneficiary of inherited IRAs, which may now contain provisions that are counterproductive.  Consider a trust created for a non-spouse beneficiary that states that only the RMDs are to be distributed, a somewhat common practice designed to attain maximum tax deferral and ration the funds.  Since there is no requirement about when during the 10 years the assets must be distributed, it could create a situation where the beneficiary can’t access the funds until they are required to be distributed at the end of the 10th year.

 

Conduit trusts have been used extensively in estate planning to receive inherited IRAs because they allow further control of the plan assets and only distribute out required distributions, taxed at the beneficiary’s tax rate.  With the new act, these trusts would be required to distribute everything outright to the beneficiary within 10 years, still taxed at the beneficiary’s tax rate but potentially at a much younger age than desired.  An Accumulation trust can be used instead which would allow the trust to retain and accumulate the required distributions, continuing the protection and control often desired when beneficiaries are young.  The downside now of an Accumulation trust, however, is that the assets will be distributed to the trust within the 10 years, bunching the income and subjecting it to the compressed trust tax rates, likely resulting in higher total taxes.  You can, of course, distribute income to the beneficiary for taxation at their rate, effectively giving the funds outright.

 

From a planning perspective, flexibility seems to be the key.  The trustee can be given discretion to distribute required distributions or other amounts also, solving the first problem above.  The trust can also be drafted to contain Trust Protector language which could give that independent individual the authority to make certain changes to the administrative provisions of the trust in order to maintain flexibility as situations change, and the law’s interpretation and relevant planning is refined.  For example, the Trust protector could change between a Conduit trust and an Accumulation trust, and vice versa.  This would be helpful in several situations including if a beneficiary became disabled and could now qualify for the stretch technique.

 

Also, with the seemingly diminished tax benefits of inherited IRAs, utilizing these qualified plan assets for charitable planning will be more attractive than ever.  Most simply, to the extent a client wants to benefit a charity upon their death, the IRA, instead of other assets, could be donated to the charity by designating that organization as the beneficiary, solving the tax problem via its tax-exempt status.  Another bonus is that any charitable bequest would also reduce the taxable estate.  And, for those clients who are currently giving to charity, consider giving future donations from IRA assets.  Prior to the age of 70 ½ there would be a taxable distribution to the client and then a partially offsetting charitable deduction for the donation.  Even more seamless are Qualified Charitable Distributions (“QCDs”), which can begin after the age of 70 ½, where there is no taxable distribution to the client if donated directly to a qualified charity.  QCDs are limited to $100,000 per year but do count toward the client’s RMD.

 

Every client’s situation is unique but, in light of the SECURE Act’s critical changes to inherited IRA distribution rules, everybody with an IRA could benefit from a review. For a comprehensive review of your personal situation, always consult with a tax or legal advisor.

 

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