By Scott A. Dondershine, CPA, Esq.

December 2019

The holiday season has historically been a time of enhanced activity for business, tax and estate planning lawyers and this year is no exception. On January 2, 2013, for instance, President Obama signed into law the American Taxpayer Relief Act of 2012. The 2012 Act contained many important developments including introducing the concept of “portability” into estate tax law. Portability significantly changed the way estates are taxed.

A few years late, on December 22, 2017, President Trump signed into law the Tax Cut and Jobs Act of 2017 covering a wide variety of topics affecting individuals, businesses and estates/trusts. See an earlier Client Alert on one of the more interesting provisions contained in the 2017 Tax Act at our firm’s website.

This year, on December 20, 2019, President Trump signed into law the “Setting Every Community Up for Retirement Enhancement (SECURE) Act.” The SECURE Act, while not as far-reaching as the two other holiday/vacation-enders discussed above, made several changes affecting qualified retirement plans, including IRAs. This Client Alert focuses on one of the changes: an important revision to the required minimum distribution rules applying after the death of the employee plan participant/IRA owner.

We’ll first explain the existing rules, next the change and finally the impact of the change on estate plans and revocable living trusts, in particular.

I. Pre-Act Minimum Distribution Rules. Although a complete review of the applicable rules prior to passage of the SECURE Act is not possible in the context of this Client Alert, it is easier to understand the changes with an explanation of the existing rules first. The goal in taking distributions from a qualified plan after the death of the employee or IRA owner is to “stretch” the payment period, thereby delaying taxation of the benefits. Stretching is accomplished by distributing the “minimum” amount that must be distributed pursuant to the “required minimum distribution” rules.

The statutory rule used to be that distributions are generally required to begin within one year after the employee’s or IRA owner’s death (or such later date as prescribed in the regulations) and are allowed to be paid over the IRS-deemed life expectancy of the designated beneficiary. If the designated beneficiary is the individual’s surviving spouse, the spouse could elect to “rollover” the benefits into the spouse’s own IRA as though the spouse were the employee or IRA owner, potentially providing for a longer “stretch”.

If the beneficiary is a non-spouse designated individual beneficiary, such as a child, then the benefits could be paid over the life expectancy of the designated child (and in the case of multiple children, the life expectancy of the oldest child). A revocable trust could meet the rules and thereby allow for a “stretch” over the life expectancy of the designed beneficiary by meeting certain tests.

Using the so-called “conduit trust” approach has generally been the safest approach to meeting the requirements. The conduit trust structure requires distribution to a beneficiary of not less than the required minimum distributions received by the trust from the applicable retirement plan or IRA. Distributing the minimum amount (with the possibility but not requirement for more) allowed for a stretch since the required minimum distributions in any given year are usually not that large. The estate planning benefits of a trust, including enhanced creditor protection for the beneficiaries and control until children have attained certain ages, could then be achieved for the balance not distributed.

II. Revised Rules. The SECURE Act changed the above rules, severely curtailing the “stretch” strategy. The new Act is generally effective for distributions with respect to plan participants/IRA owners who die after December 31, 2019.

Pursuant to the SECURE Act, the general rule is that after an employee or IRA owner dies, the remaining account balance must be distributed to designated beneficiaries within 10 years after the employee’s or IRA owner’s death. Exceptions to the 10-year rule are allowed for distributions to (1) the surviving spouse of the plan participant or IRA owner; (2) a child of the plan participant or IRA owner who has not reached majority (this exception only applies until the minor reaches the age of majority, at which time the new 10-year period applies); (3) a chronically ill individual; and (4) any other individual who is not more than ten years younger than the plan participant or IRA owner. A beneficiary who qualifies under one of the above exceptions (other than as noted above for a minor child in (2)) may generally still receive distributions over his or her life expectancy, as allowed under the rules in effect for deaths occurring before 2020.

III. Impact to You. A spouse should, in most instances, still be named the primary beneficiary outside of a revocable trust in order to take advantage of any rollover opportunities only available to the spouse. As for the contingent beneficiaries to take after the spouse’s death and in light of the revised rules, we recommend that clients review whether it continues to make sense to name a revocable trust the contingent beneficiary of an IRA or other retirement plan.

Trusts that contain conduit trust provisions requiring compliance with the required minimum distribution rules may continue to work depending upon how the provisions are worded and the goals of a client. And, naming a trust the contingent beneficiary still works in order to take advantage of the creditor and other protections of a trust. Although the effective period of protection offered by trusts with respect to plan assets is now limited to 10 years, the 10-year period applies regardless of the use of a trust.

However, a trust named as the contingent beneficiary may need to be reviewed and revised. For instance, if the conduit trust provisions limit the amount of any distributions to the required minimum distribution amount, then the money could be held up until after year 10 when it must all suddenly be distributed. But, if the conduit trust allows for distributions beyond the amount of the required minimum distribution amount, then depending upon the actual wording of the trust the trustee should have sufficient flexibility to make distributions throughout the 10-year period, thereby avoiding the potential for a large unplanned distribution after the end of the 10-year period.

Clients may also want to reconsider the beneficiary designations of their IRAs or other retirement plans since distributing over the lifetime of a child will no longer work. Some clients may prefer to name one of the three non-child exception beneficiaries noted above as opposed to children and provide other assets to children to make up for the difference, if possible. Other ideas to consider given the new rules include using charitable bequest strategies for IRA or qualified plan assets (and swapping other assets for allocation to the kids), timing distributions to coincide with available planned tax deductions, and providing flexibility for a beneficiary to disclaim benefits in favor of contingent beneficiaries that are in a lower tax bracket.

This Client Alert is intended as an introduction only to the topics addressed – it is not a full discussion of the issues. Let us know if you want to discuss the issues in this Client Alert in greater detail or have other questions regarding other areas of the new tax law.

DISCLAIMER. This Client Alert does not provide legal advice. We are providing it for general informational purposes only.