The Setting Every Community Up for Retirement Enhancement (SECURE) Act changed I.R.C. Code § 401(a)(9) so that, in most cases, a beneficiary who is not a surviving spouse must take distributions from IRAs and other retirement plans over a period not exceeding 10 years, rather than using his/her life expectancy. Rather than delving into technical details, this article explains certain strategic issues that CPAs may need to explain to their clients. This article paints with a broad brush to provide a strategic overview and should not be relied by itself; instead, go look at Natalie Choate’s scholarship at https://ataxplan.com. For finer technical details, American College of Trust and Estate Counsel (ACTEC) Comments on the SECURE Act are linked here.

This article refers to IRAs below because most qualified plan accounts are converted to inherited IRAs. Below, “owner” refers to a participant in a qualified retirement plan, an IRA owner, or a similar person accumulating tax-deferred retirement benefits. First, we discuss who is a designated beneficiary. Next, we discuss rules when not using a beneficiary’s life expectancy.  Finally, we discuss strategic issues.

Who Is a Designated Beneficiary?

Now, the only ones who may receive distributions over their lives (an eligible designated beneficiary, or EDB) are the owner’s surviving spouse, the owner’s minor child, a disabled individual, a chronically ill individual, or an individual who is not more than 10 years younger than the owner. Also, when a minor child reaches majority, the child must withdraw the IRA within 10 years.

A beneficiary who is not an EDB may take distributions over 10 years only if the beneficiary is an individual. If the beneficiary is a trust, it may receive that treatment only if it is solely for the benefit of one or more individuals. A trust qualifies only if all distributions must be made immediately after distribution to one or more individuals (a “conduit trust”) or if any reinvested distributions must eventually be distributed to one or more individuals (a “qualified accumulation trust”). A qualified accumulated trust that has IRA and non-IRA assets requires significant accounting, because the reinvested distributions must be devoted exclusively to individuals, and even subsequent trusts must keep tracking these reinvested distributions.

Generally, a trust can qualify as an EDB only if the trust is only for the benefit of one or more EDBs.  In many cases, given the unpredictably of the status of the remaindermen (those who take when the trust’s primary beneficiary dies), the trust needs to be a conduit trust.  However, it appears that a trust for the benefit of only a disabled or chronically ill individual during his/her life may qualify as an EDB without being a qualified accumulation trust.

Not Using the Life of a Designated Beneficiary

If the owner did not have a qualified designated beneficiary and had started taking required minimum distributions before dying, then one may be able to use what is referred to as the “ghost” life expectancy. One looks to the owner’s life expectancy and subtracts 1 from that life expectancy each year and must take distributions every year. For distribution calendar years beginning on or after January 1, 2022, one’s life expectancy is 17.2 at age 72 and 10.5 at age 81.

If the owner did not have a qualified designated beneficiary and had not started taking required minimum distributions before dying, then the entire account must be distributed within five years but need not be distributed at all until the end. For example, if the owner dies any time during 2021, one could wait to take any distributions until distributing everything left in the account on December 31, 2026.

If the owner had a qualified designated beneficiary who is not an EDB, distributions must be made within ten years. Our best guess is that the ten-year rule would work like the five-year rule, in not requiring any distribution until the end of the period.

Strategy

Below are some reasons why I advocate significant flexibility.

If an IRA is relatively modest, complex planning may be inappropriate. If one has a $100,000 IRA and two beneficiaries that are trusts that do not qualify, so that the five-year rule applies, the IRA might be distributed (ignoring investment return) as $10,000 to each beneficiary each year. That seems very manageable in many cases. Even if each trust accumulates its distributions, if the trust has no other income, then the trust is not yet in the top bracket.

If the IRA is very large, then complex planning may be very important to balancing income tax concerns against the owner wanting to accumulate funds if distributions are harmful. Distributions may be harmful in a continuum of cases, whether the beneficiary is a drug addict, a “trust fund baby,” a vulnerable person, or a very responsible person who needs to avoid estate tax.

However, an IRA that is very large today may become relatively modest, due to distributions from the time of planning until the owner dies. Also, beneficiaries’ circumstances may change, and the owner might not even be aware of what happened; even in a very close relationship, the beneficiary may develop a sudden illness or injury that affects his/her decision-making ability and the owner might not have an opportunity to make appropriate changes.

If accumulating IRA distributions is important, does one always need the complexity of a qualified accumulation trust? Although the ghost life expectancy does not provide as much deferral as waiting to make a distribution at the end of ten years, spreading distributions over a period of time can smooth income recognition and provide sufficient benefits, while eliminating the complexity of separate accounts.

For all these reasons, trusts I have drafted after the SECURE Act became effective include significant flexibility to change a trust before the beneficiary finalization deadline. As to the latter, Treas. Reg. section 1.401(a)(9)-4(A-4)(a) allows beneficiaries to be eliminated on or before September 30 of the year after the owner’s death (9/30/3022 for 2021 decedents), and that elimination would be deemed retroactive to the date of the owner’s death. Some may be uncomfortable regarding whether the flexibility might cause the trust to lose its qualification as a see-through trust that allows identification of only qualified beneficiaries; if the client has material retirement plan assets in a qualified plan (instead of an IRA), consider being much more cautious about this flexibility than one might otherwise be.

If the owner would leave the IRA outright to a non-spouse beneficiary, consider instead leaving the IRA to a conduit trust for that person. That way, if the beneficiary unexpectedly becomes incapacitated, a trustee can take appropriate steps to manage the IRA (or otherwise change the trust before the beneficiary finalization deadline) without establishing a conservatorship for the beneficiary. Furthermore, the trustee may be authorized to terminate the trust at any time, so that the IRA can become payable directly to the beneficiary.

Suppose the IRA is payable to a trust that is intended to be excluded from the beneficiary’s estate for estate tax purposes, but ideally the beneficiary would pay the income tax on the reinvested IRA distributions. The trustee might place the IRA distributions in a separate account and grant the beneficiary the power to withdraw that account, thereby taxing the beneficiary as if the beneficiary had received the IRA distributions.-Over time, the withdrawal right might lapse within the limits of I.R.C. § 2514(e) (an annual lapse of 5% of the assets from which the withdrawal right could be satisfied), which does not count as a gift for federal gift tax purposes.  The law underlying such a power has been discussed (Gorin, part II.J.4.f. Making Trust a Partial Grantor Trust as to a Beneficiary, “Structuring Ownership of Privately-Owned Businesses: Tax and Estate Planning Implications”) in a few thousand-page PDF on estate planning available by download from the author’s most recently quarterly newsletter, to which NYSSCPA members may subscribe for free at http:\www.thompsoncoburn.com\forms\gorinnewsletter. (I have more confidence in this for trusts governed by New Jersey or Connecticut law than I have in, New York law.)

If the owner is in a long-term marriage to a spouse who is not a parent of the owner’s children, the owner might consider leaving part of the IRA to a marital trust that is a conduit trust, allowing distributions to be stretched over the spouse’s annually recalculated life expectancy.  This does not ensure that the children will receive anything if the spouse survives a long time, but it does ensure that they will receive the remaining IRA if the spouse dies prematurely.

If the owner has significant charitable intent, the owner may avoid the SECURE Act completely by the leaving the IRA to a charitable remainder trust (CRT) under I.R.C. § 664.  The IRA is paid immediately to the CRT, but is not taxed until distributed to the beneficiary – generally annually 5% of the CRT’s assets. Any investment income, including capital gain, is not taxed until the IRA distributions have been taxed. When the beneficiary dies, the CRT’s assets pass to charity, free from tax.

Detailed provisions that may be included in trusts are found in my materials for the FAE/NYSSCPA Estate Planning Conference Webcast on October 28, 2021.

Steven B. Gorin, CPA, Esq., CGMA, is a partner in Thompson Coburn LLP. He is a Regent and chairs the Employee Benefits Committee of the American College of Trust & Estate Counsel and former chair of the Business Planning Group of Committees of the American Bar Association’s Real Property, Trust Estate Law Section. He is a member of NAEPC’s Estate Planning Hall of Fame. For more information about the author, please visit  http://www.thompsoncoburn.com/people/steve-gorin and https://www.thompsoncoburn.com/insights/blogs/business-succession-solutions/about.