The SECURE Act, which went into effect in January 2020, changes the way people receive money from inherited retirement accounts. However, not all beneficiaries are impacted in the same way.
Under the SECURE Act, if an IRA beneficiary is not considered an “Eligible Designated Beneficiary,” they must fully distribute inherited IRA funds within 10 years following the year of death of the original IRA owner (for IRA owners dying after 12/31/2019).
Eligible Designated Beneficiaries include:
- Minor children;
- Disabled/chronically ill beneficiaries; and
- Beneficiaries less than 10 years younger than the original IRA owner.
A Difficult Decision – What About A Trust?
Many people have named a revocable living trust as a beneficiary of IRA assets with the goal of protecting IRA assets in trust for their children and grandchildren post death. Because of the RMD rule changes, you may be faced with an increasingly difficult decision – “What do I value more … asset protection … or income tax minimization for my children and grandchildren?”
Before the SECURE Act, this decision was much easier. You could get the best of both worlds by including “Conduit Trust” provisions in your trust document. A Conduit Trust provision allowed you to both hold IRA funds in trust for your beneficiaries and maximize opportunities for your beneficiaries to stretch IRA RMDs over the eldest trust beneficiary’s life expectancy. However, with this strategy there was one catch – the Trustee of a Conduit Trust is required to withdraw the RMD amount from the IRA and then distribute the amount withdrawn directly to the trust beneficiary.
Thus, under the new SECURE Act rules, a Trustee of a Conduit Trust is now required to fully withdraw IRA funds and distribute those amounts directly to a trust beneficiary within 10 years following your death (assuming you named a Conduit Trust as a beneficiary of your IRA). This means that trust principal may be distributed to young beneficiaries earlier than you intended.
For example: If you intended principal to be held in trust for your beneficiaries until age 45, under the new rules, the Trustee of a Conduit Trust is required to fully distribute IRA funds held in trust directly to an 18-year-old beneficiary within 10 years (by age 28).
It is still possible to protect IRA funds in trust for beneficiaries beyond 10 years by structuring your trust as an “Accumulation Trust” which gives the trustee discretion on how to make distributions, but there is a major downside. With an Accumulation Trust, the Trustee is still required to fully withdraw IRA funds within 10 years following the year of your death, but if the funds stay in trust, the IRA distributions are taxed at trust and estate income tax rates. In many cases, this means that the IRA distributions will be taxed at the highest marginal tax rate of 37% (because the 37% rate starts at $12,951 for estates and trusts).
As you can see, this conflict between asset protection and income tax savings can put you in a difficult situation post-SECURE Act.
Does a Conduit Trust or an Accumulation Trust Make Sense for Me?
You may now be asking: What is better, a Conduit Trust or an Accumulation Trust? The answer depends on several factors, including:
- What do you value more … minimizing income taxes for the next generation … or providing asset protection through a trust so the money is prudently managed?
- How many trust beneficiaries do you have?
- What are the principal distribution ages set forth in your trust?
- How old are your trust beneficiaries compared to the principal distribution ages?
- How large are your IRA balances in relation to the rest of your estate?
- What are your trust beneficiaries’ individual tax rates?
- Is asset protection planning for multiple generations important to you?
- Is your family well equipped to handle additional administrative complexity post death?
No One-Size-Fits-All Solution
There is no “blanket” or “one-size-fits-all” guidance on what will make sense for you. Each situation is unique and must be approached individually. Given the rule changes and a multitude of factors, it is critically important to coordinate with your attorney, tax advisor, and financial advisor.
Your team of professionals should review your trust documents, net worth, and IRA/qualified account balances and revisit the design of your overall estate plan so you can weigh the tax costs of leaving IRAs in trust against your asset protection goals. Each conversation will be different and, depending on your preferences and unique family situation, you may make a completely different decision than another person with a similar mix of assets.