Mar 16

The SECURE Act – Estate Planning

The “Setting Every Community Up for Retirement Enhancement Act of 2019” (“The SECURE Act”) was signed by President Trump on December 20th, 2019, as part of a larger spending bill known as the “Further Consolidated Appropriations Act, 2020.” Probably the most important change for retirement plans is that many inherited retirement accounts will have to be paid out to the beneficiary over a much shorter period of time.

Step 1. Review the changes to retirement plans outlined below in Table 1.

Step 2. Evaluate your estate planning concerns to determine a course of action using Table 2.

Table 1 – Summary of the SECURE Act changes relevant to Estate Planning

 

Inherited Retirement Accounts – New Required Minimum Distributions Rules for all Retirement Accounts

New SECURE Act Laws

For people passing away on or after January 1, 2020, and with the exceptions listed below, inherited retirement accounts must be distributed to the beneficiary over a 10-year period following the death of the participant.

Five exceptions to the 10-year payout rule:

  • The surviving spouse of the employee;
  • A child of the employee who has not attained the age of majority;
  • A disabled individual;
  • A chronically ill individual; or
  • Any individual who is not less than 10 years younger than the employee

Prior Law

Inherited retirement accounts could generally be distributed over a longer period using the beneficiary’s life expectancy or the decedent’s remaining life expectancy.

 

No Age Restrictions on Contributions To IRAs

New SECURE Act Laws

IRA participants who are otherwise eligible to make IRA contributions can now do so without any age restrictions.

Prior Law

Eligible IRA participants could not make contributions to IRAs for the year they attained age 70.5 and thereafter.

 

Qualified Charitable Distribution Offset

New SECURE Act Laws

For IRA participants who make deductible IRA contributions for the tax year that they attain age 70.5 or thereafter, their Qualified Charitable Distributions (“QCDs”) for the tax year are reduced by the amount of the deductible IRA contribution taken in years after attaining age 70.5.

Prior Law

Prior law did not provide for a reduction in Qualified Charitable Deductions for deductible IRA contributions.

 

Change in Required Beginning Date

New SECURE Act Laws

The Required Beginning Date for distributions from retirement accounts is April 1st of the calendar year after the participant attains age 72. This change only applies to participants who attain age 70.5 on or after January 1, 2020.

Prior Law

The Required Beginning Date was April 1st of the calendar year after the year the participant attained age 70.5.

 

New Exception to the Pre-59.5 10% Early Withdrawal Penalty

New SECURE Act Laws

An additional exception to the pre-59.5 10% early withdrawal penalty has been added for retirement plan distributions of $5,000 per birth or adoption.

Prior Law

Prior law did not provide this exception to the pre-59.5 10% early withdrawal penalty.

Table 2 – Overview of Key Planning Concerns and Choices for the new 10-year Rule

 

If I have these concerns, who should be named as the beneficiary of my retirement account?

Asset/Spendthrift Protection

Name an Accumulation Trust as the beneficiary of the retirement account.

Asset Protection and Tax Efficiency

Name a specially drafted Trust that will tax the beneficiary on the retirement account distributions while allowing the beneficiary to decide if the distributions should remain in trust or be withdrawn from the trust.

Tax Efficiency

Name the beneficiary as the direct heir to the retirement account, with named contingent beneficiaries.

Most people will choose this option.

Charitable Intent

Name a Charitable Remainder Trust (“CRT”) as the beneficiary of the retirement account.

 

What are the pros and cons of this choice?

Asset/Spendthrift Protection

Trusts have compressed tax brackets and taxes may be higher. See tax rates in Table 3 below. Trusts provide asset protection and trustees can provide proper management. Trust have administration costs.

Asset Protection and Tax Efficiency

The distributions will be taxed at the beneficiary’s tax rates. Careful trust drafting is required. The beneficiary must understand the withdrawal mechanism. This option is more complex.

Tax Efficiency

Reduces tax leakage if the beneficiary is in a lower bracket than a trust. The beneficiary will have control over the distributed funds as well as the account, and creditors may have access to the distributed amounts.

Charitable Intent

CRTs do not pay income upon receipt of the retirement proceeds. You determine the period of time for distributions to your heirs. The heirs are taxed on the CRT distributions over time.

 

Why would I make this choice?

Asset/Spendthrift Protection

The beneficiary may have asset protection needs or may waste the assets frivolously. For special needs persons, the accumulation trust must be properly drafted to minimize distributions from the retirement account.

Asset Protection and Tax Efficiency

You may want the asset protection a trust provides but have the option to reduce the income tax leakage. The beneficiary is responsible but would like the trust to grow outside of his or her taxable estate. The beneficiary has the financial ability to pay the income taxes without receiving a trust distribution.

Tax Efficiency

The beneficiary is responsible, is in a lower tax bracket, has no asset protection needs and will invest the after-tax proceeds responsibly.

Charitable Intent

You are truly charitably inclined, but you would also like to benefit your heirs.

 

I. Overview of the 10 Year Distribution Requirement for Retirement Plans

For retirement plan participants who pass away on or after January 1, 2020, the retirement plan beneficiaries must distribute the balance of the plan account within 10 years after the death of the employee. There are 5 classes of “Designated Beneficiaries” (individuals) who are also called “Eligible Designated Beneficiaries” who are exempt from this new 10-year distribution rule:

  • The surviving spouse of the employee;
  • A child of the employee who has not attained the age of majority;
  • A disabled individual;
  • A chronically ill individual; or
  • Any individual who is not less than 10 years younger than the employee.

Upon the death of an Eligible Designated Beneficiary, the retirement account must be distributed within 10 years after the death of the Eligible Designated Beneficiary. Also, once a minor child of the employee has attained the age of majority, the retirement account must be distributed within 10 years after the date the child attained the age of majority. There is also an exception for multi-beneficiary trusts that only applies to chronically ill or disabled beneficiaries, provided certain conditions are met.

Note that the SECURE Act did not provide any guidance as to how distributions should be taken over the 10-year period, so it is conceivable that there could be no distributions until the final year of the 10-year period. The Treasury may provide guidance on how distributions should be taken over the 10-year period, but as of yet, no guidance has been provided.

II. Situations and Solutions

A. Many Plans may not need changes

While many retirement plans will be affected by the new rules, most beneficiary designations and estate plans may not require changes — provided the plan participant has already evaluated and addressed his or her primary estate planning concerns. For most family situations, each spouse names the other spouse as the primary beneficiary of their respective retirement plans, and the children or other beneficiaries are named as the contingent beneficiaries.

Generally, a surviving spouse who has not attained age 59.5 may leave an inherited retirement plan as an “inherited account” if the surviving spouse needs distributions from the retirement account and wants to avoid the 10% penalty on distributions. Because the 10% penalty on early withdrawals does not apply if the plan participant has attained age 72, most surviving spouses who have attained age 59.5 will elect to treat the inherited retirement plan “as their own” retirement plan to postpone required distributions until age 72.

Similarly, families that have already identified asset protection concerns or spendthrift concerns may already have determined that their retirement plan assets should be payable to an “accumulation trust”, which is simply a carefully drafted trust that is irrevocable after the plan participant passes away. These types of trusts, however, may merit changes on who pays the income tax on the retirement plan distributions due to the curtailed 10-year distribution period and, much of the prior language under the old rules will need to be updated.

B. Surviving Spouse

After the first spouse passes away, the surviving spouse is an “Eligible Designated Beneficiary” and the surviving spouse’s age is used to determine post-death distribution amounts. If the surviving spouse leave the account as an “inherited account,” then after the surviving spouse passes away, the remaining account must be distributed within 10 years of the surviving spouse’s death even if the next beneficiary is an “Eligible Designated Beneficiary.”

If the surviving spouse has an “Eligible Designated Beneficiary” that may be the desired beneficiary after the surviving spouse’s death, the surviving spouse should consider making an election to treat the inherited retirement account “as their own” retirement account. This way, the surviving spouse can provide additional planning for distributions beyond the 10-year rule for the subsequent “Eligible Designated Beneficiary” and will also have reduced the amount of the required minimum distribution that would have been required during the surviving spouse’s lifetime.

C. Asset Protection

Are there reasons why a plan participant might not want the entire IRA distributed to one or more of their heirs? Is it a second or third marriage, or is a child an uncontrollable spendthrift or a minor? Perhaps a beneficiary is engaged in lucrative but risky profession or business that is fraught with lawsuits?

For these situations, a plant participant may want to name a trust as the beneficiary of all or some portion of their retirement account. The trust must be properly drafted to qualify as a “Designated Beneficiary” and the trust can be drafted so that the qualified plan distributions are accumulated inside the trust rather than being distributed to the beneficiary. These trusts are called “accumulation trusts” and provide a certain level of asset protection to the retirement plan distributions and other assets owned by the trust.

The trade-off for using an “accumulation trust” as the beneficiary of a retirement account is that the income taxed to these trusts are taxed at compressed tax brackets for ordinary income and capital gains as compared to individual taxpayers. The compressed tax bracket schedule for accumulation trusts may not make a large difference if a beneficiary is already in the highest marginal income tax brackets. But if there is a large disparity between the trust’s tax rates and the beneficiary’s tax rates, then over long periods of time taxing the income in the beneficiary’s tax brackets rather than in the trust’s compressed tax brackets can significantly add to the value and growth of the assets retained by the participants family.

Table 3, below shows the compressed income tax brackets for estates and trusts, as well as the income tax brackets for individuals filing “married filing jointly” and “single.” A trust reaches the maximum ordinary tax rate at only $12,950 of income, whereas an individual filer doesn’t reach the maximum ordinary tax rate until his or her income exceeds $518,400 of ordinary income. The capital gains tax rates and brackets are also compared in Table 3. Note that the accumulation trust reaches the 20% capital gains rate at only $13,150 as compared to $441,500 for individual filers.

Table 3 – Relevant Income Tax Brackets and Tax Rates (2020)

 

Non-Grantor Trust/Estate

Single

Married Filing Jointly

Ordinary Income Tax Rates

Taxable Income

Taxable Income

Taxable Income

10%

$0 – $2,600

$0 – $9,875

$0 – $9,875

12%

 

$9,875 – $40,125

$9,875 – $40,125

22%

 

$40,125 – $85,525

$40,125 – $85,525

24%

$2,600 – $9,450

$85,525 – $163,300

$85,525 – $163,300

32%

 

$163,300 – $207,350

$163,300 – $207,350

35%

$9,450 – $12,950

$207,350 – $518,400

$207,350 – $311,025

37%

$12,950 –

$518,400 –

$311,025 –

Long Term Capital Gain Tax Rates

 

 

 

0%

$0 – $2,650

$0 – $40,000

$0 – $80,000

15%

$2,650 – $13,150

$40,000 – $441,450

$80,000 – $496,000

20%

$13,150 –

$441,450 –

$496,000 –

Net Investment Income Tax Rate

 

 

 

3.8%

AGI > $12,950

MAGI > $200,000

MAGI > $250,000

Standard Deduction

$-0-

$12,400

$24,800

 

 

 

 

Personal Exemption

Trusts – $300 or $100
Estates – $600

$-0-

$-0-

 

D. Income Tax Shifting Accumulation Trusts

These types of trusts are often called “beneficiary defective trusts”, “beneficiary deemed owner trusts”, and other interesting names. These trusts are designed in compliance with specific Internal Revenue Code statutes to shift the ownership of the income away from the “accumulation trust” and its compressed tax brackets to the beneficiary’s income tax brackets.

For irrevocable trusts that are the beneficiary of a retirement account, the income tax ownership of the taxable income of the trust can be shifted between the trust and the beneficiary by drafting into the trust the ability of the beneficiary to withdraw the taxable income from the trust on an annual basis. Whether withdrawn or not, the beneficiary is taxed on the trust’s taxable income for that year. Perhaps the beneficiary should withdraw enough cash or assets to pay the beneficiary’s income tax liability relating to the additional income included in the beneficiary’s income.

When considering this form of income shifting, the plan participant must consider if it is prudent to give the beneficiary this withdrawal power. The withdrawal power may be modified prospectively by the trustee, a trust protector, or a committee of professionals. The beneficiary’s power to make withdrawals of the trust’s taxable income for the year is a sophisticated way to balance asset protection goals and income tax reduction goals. The withdrawal power must be carefully tailored so that some portion of the trust assets are not included in the beneficiary’s taxable estate after the lapse of the power of withdrawal. Needless to say, careful drafting is required to achieve all of the desired results.

E. Minor Children

A plan participant may not want to have retirement plan distributions made to a minor child. In Florida, a parent of a minor can only manage assets up to a value of $15,000 before a guardianship is required. An “accumulation trust” is a good option if there exists a possibility that a minor child may become the recipient of a substantial retirement account.

In Florida, a child attains the age of majority upon attaining age 18. However, the relevant regulations allow a child to be treated as the employee’s child if the child has not completed a specified course of education that is being pursued and has not attained age 26. Therefore, if the circumstances merit, the required distributions may be based upon the old “stretch rules” until the child attains age 26, and then for another 10 years under the SECURE Act 10-year payout rule. For minors who are not pursuing an “specified course of education”, the old “stretch rules” can be used until the child attains age 18, and then for another 10 years under the SECURE Act 10-year payout rule.

As noted above, the SECURE Act did not provide any guidance as to how distributions should be taken over the 10-year period, so it is conceivable that there could be no distributions until the final year of the 10-year period thereby allowing further tax free growth until the year the child attains age 36 or 28, as the case may be. Of course, an 18 year old may very well demand that the money be distributed immediately for any reason.

F. Special Needs Trusts

Plan participants who have beneficiaries with special needs considerations may want to name a trust benefiting special needs heirs as the primary or contingent beneficiaries of their retirement accounts. Special needs trusts are basically “accumulations trusts” that allow the trustee full discretion to make or not to make distributions for the beneficiary’s benefit. Many times the permissible distributions are limited so that government benefits are not impacted.

These special needs trusts should be reviewed to determine if the distribution provisions comply with the SECURE Act rules for trusts for disabled or chronically ill persons. If the trust qualifies under the new rules, the required minimum distributions from the retirement plan will be based upon the beneficiary’s life expectancy using the pre-SECURE Act rules.

In general, trusts for disabled persons that also have non-disabled persons as beneficiaries must provide that no distributions can be made to a non-disabled beneficiary until the disabled person (the “eligible designated beneficiary”) has passed away.

G. Charitable Remainder Trusts

For the truly charitably inclined, making a Charitable Remainder Trust the beneficiary of a retirement account may be viable option because the Charitable Remainder Trust does not pay income tax on the receipt of distributions from the retirement account. Further, the Charitable Remainder Trust can be drafted so that distributions to the intended heir can be distributed over 20 years if a term trust is used, or over the lifetime of the intended beneficiary.

Of course, the distributions to the intended beneficiary will carry out taxable income in accordance with the tiered income distributions rules for Charitable Remainder Trusts, but at least the income taxes can be significantly deferred over the distribution period set forth in the Charitable Remainder Trust. Assets remaining in the Charitable Remainder Trust must be distributed to qualified charities, so it is imperative that this option is only use by people with substantial charitable intent.