On December 20, 2019, President Trump signed the Setting Every Community Up for Retirement Enhancement Act (SECURE Act). The SECURE Act, which is effective January 1, 2020, is the most impactful retirement legislation of the past decade. It increases the age for required minimum distributions from retirement accounts from 70 ½ to 72 years of age. However, among the many provisions in the new law involving retirement accounts, the most significant for those with retirement accounts is the elimination of the “stretch” option for non-spouse designated beneficiaries who inherit a retirement account. Previously, beneficiaries of inherited retirement accounts could take distributions over their life expectancy. Under the SECURE Act though, the shorter ten-year time frame for taking distributions will likely result in the income tax due being accelerated and possibly causing the beneficiaries to be bumped into a higher income tax bracket, thus receiving less of the funds contained in the retirement account than originally anticipated. MANDATORY DISTRIBUTIONS IN 10 YEARS AFFECTS ASSET PROTECTION. Life Insurance should be considered to pay the income taxes at the time of distribution. ILITs are back too – for income tax planning now instead of estate tax planning.
Because of this monumental change in the way inherited retirement accounts are treated, it is crucial to plan accordingly. Keeping an eye on income tax consequences and asset protection needs, there are several strategies that we can collaborate on to address this new paradigm.
Revocable Living Trust (RLT) or Standalone Retirement Trust (SRT)
Now that most beneficiaries are required to withdraw the entire balance of a retirement account within ten years of the owner’s death, an RLT or SRT might be the best estate planning tool for these unique assets. We should, however, reconsider the use of “conduit” trust provisions because they require any required minimum distributions (RMDs) to be distributed directly to the beneficiary through the trust. Under the SECURE Act, the balance of the account would have to be distributed directly to the beneficiary at the end of year ten, which is an outcome most might want to avoid for any number of reasons, i.e. asset protection of the inherited accounts, keeping the inherited accounts out of divorce proceedings of the children and grandchildren.. Now, an “accumulation” trust provision may be more beneficial. This provision allows the trustee to receive the required minimum distributions (RMDs) from the retirement account as often as required by law but allows the trustee to exercise discretion as to when and how much of the funds are distributed to or used for the benefit of the beneficiary. Although the trust will pay income tax on any of the distributions from a retirement account that are not distributed to the beneficiary, for many beneficiaries, it is equally or more important to protect the money from the beneficiary’s creditors, divorces, or lawsuits.
If you named your RLT or SRT as beneficiary of retirement account, it is important that an attorney review the planning documents. If the trust contains “conduit” provisions, an amendment to the trust may be appropriate. We can help with this.
Charitable Remainder Trust (CRT)
A charitable remainder trust may be the right solution to plan for the disposition of the retirement accounts. Such a trust would allow the client, as the grantor, to name beneficiaries to receive an income stream from the retirement account for a period of time, with the remainder going to a charity named in the trust agreement. CRTs might be the closest thing to an SRT or inherited stretch IRA going forward.
When the trust is created, the net present value of the remainder interest must be at least ten percent of the value of the initial contribution. It can be payable for a term of years, a single life, joint lives, or multiple lives. Upon the plan participant’s or account owner’s passing, the estate will receive a charitable deduction for distributing the retirement account to the trust, and the distribution from the retirement account to the CRT is not taxed. However, distributions from the CRT to the beneficiaries will be subject to income tax. Another benefit to this strategy is that the distributions to the beneficiaries will be smaller and therefore subject to less income tax liability.
It is important to note that this strategy is best for individuals who are already charitably inclined. This strategy may not result in the beneficiaries getting more than they would have utilizing other estate planning strategies, but if you already wish to provide for a charity, this may achieve your goals in a more tax favorable way.
Irrevocable Life Insurance Trust (ILIT)
Due to the new ten-year mandatory withdrawal rule, there will be an acceleration of the beneficiaries’ income tax on inherited retirement accounts, potentially moving them into a higher income tax bracket in an unprotected manner. The new rule may also result in the amount of cash available to beneficiaries being less than you originally anticipated. In order to help offset this shortfall, you may want to consider using funds from the retirement accounts during your life to purchase additional life insurance and transfer ownership of the policy to an ILIT. The ILIT will help protect the insurance funds from the beneficiary’s creditors and, if desired, can be designed so that the proceeds from the life insurance policy are not includible in your estate. In much the same way that ILIT’s created liquidity in the past for estate taxes, now ILITs can create liquidity for income tax obligations associated with retirement accounts.
Multi-Generational Spray Trust
Any number divided by a large number results in a smaller number. The same philosophy is true with distributions involving retirement accounts. While the distributions must be made within ten years, by distributing the retirement account to multiple beneficiaries at the same time over the ten-year period, the RMDs received by each beneficiary will be smaller, and the resulting tax liability per beneficiary will be reduced.
For asset protection purposes, it is always advisable that the distributions be made to a trust for the benefit of a beneficiary instead of directly to the beneficiary.
Inherited retirement accounts will not provide the same benefits post-SECURE Act. By working together, we can help navigate the new rules. It might be important to review your existing planning documents or explore new planning opportunities under the Act. Proper estate planning can provide you with peace of mind while you are living and ensure the retirement assets are passed on to loved ones in the most efficient and protected manner. Give us a call to discuss how we can tackle the SECURE Act together.