SECURE Act Update: Big Changes to Naming a Trust as Beneficiary of Your IRA

Leaving IRA assets to a trust, rather than to individual beneficiaries, can be a strategic move for those looking to exert more control over the distribution of their retirement savings. The language within the trust document allows the IRA owner to dictate how and when the assets are dispersed to the trust's beneficiaries. Additionally, a trust can provide creditor protection and prevent the IRA from being subject to the beneficiary's personal financial issues or lawsuits. This can help preserve the retirement nest egg for its intended purpose.

The SECURE Act 1.0 has significantly changed the landscape for retirement account beneficiaries. While the pre-SECURE Act 1.0 rules still apply to retirement accounts of decedents who passed away before January 1, 2020, the new rules under the SECURE Act 1.0 have drastically altered the RMD (required minimum distribution) requirements for beneficiaries of individuals who are still alive.

Prior to the SECURE Act 1.0, many beneficiaries were able to take distributions from the inherited IRA account over the course of their lifetimes through the "stretch IRA" provision. This allowed them to maximize the tax-deferred growth of the account. However, the SECURE Act 1.0 has eliminated this option for most non-eligible designated beneficiaries, requiring the full distribution of the inherited IRA within 10 years of the original account holder's passing. The elimination of the "stretch IRA" provision means beneficiaries will face a compressed timeline to withdraw the assets, potentially bumping them into higher tax brackets and reducing the long-term growth potential of the inherited funds. This can be a substantial deviation from the original owner's wishes to provide a lasting, tax-advantaged inheritance for their loved ones.

As a hypothetical example, in the case of a $1 million IRA inherited by three children, it's crucial to understand the required minimum distributions (RMDs) that each beneficiary will face in the first year. If the beneficiaries are 47, 43, and 40 years old, their respective RMDs will be approximately $9,000, $8,200, and $7,650. These figures are based on their individual life expectancies and the total value of the inherited IRA. It's important to note that these RMDs are not optional; they are mandatory withdrawals that must be taken to avoid penalties. Compared to the parent's required minimum distribution (RMD) of approximately $65,000 in the year of their death, the distributions to the children will be significantly smaller. This is especially true for the youngest child, who will have the smallest calculated distribution.

Additionally, the annual tax impact will be less, as the distributions are spread out over the 10-year period. However, note that if the parent passed away in 2020 or later, all three children must withdraw the full balance of the inherited IRA within that 10-year timeframe. This accelerates the income tax impacts and results in the loss of potential long-term growth that the account could have experienced under the previous stretch IRA rules.

Prior to the enactment of the SECURE Act 1.0, trusts needed to meet specific "see-through" requirements in order to qualify for the life expectancy stretch provisions as a beneficiary. There were four essential criteria that a trust had to fulfill:

1. The trust must be valid under the applicable state law.

2. The trust must be irrevocable.

3. All of the trust's underlying beneficiaries must be identifiable as being eligible to be designated beneficiaries themselves.

4. A copy of the trust document must be provided to the custodian by October 31 of the year following the account holder's death.

Meeting these stringent requirements was crucial to ensure the trust would be recognized as a "see-through" trust, allowing the beneficiaries to take advantage of the valuable life expectancy stretch. Failure to comply with any of these provisions could have resulted in the trust being ineligible, leading to accelerated distributions and potentially unfavorable tax consequences for the beneficiaries. Understanding and adhering to these pre-SECURE Act 1.0 guidelines was essential for estate planning professionals and their clients to preserve this important retirement account planning strategy.

The IRS's proposed regulations in February 2022 have provided much-needed clarity on the "see-through" trust rules following the SECURE Act 1.0. These regulations explicitly acknowledge the "see-through" trust concept, allowing IRA assets to be withdrawn within the 10-year period as intended by the SECURE Act.

This is a significant development, as the "see-through" trust rules are crucial for individuals who have named a trust as the beneficiary of their IRA. The proposed regulations ensure that these individuals can still take advantage of the 10-year withdrawal period, rather than being subject to the more restrictive rules that would have applied without the "see-through" trust provisions.

By including the "see-through" trust rules in the proposed regulations, the IRS has demonstrated its commitment to upholding the spirit of the SECURE Act and providing taxpayers with the flexibility they need to manage their retirement assets effectively. This clarity will be invaluable for financial advisors, estate planners, and IRA account holders as they navigate the post-SECURE Act landscape.

Another update, conduit trusts are no longer the reliable asset protection tools they once were. Recent changes in the law have significantly limited their effectiveness outside of the initial 10-year period.

Historically, conduit trusts were used to allow beneficiaries to stretch out their payments over a lifetime while keeping the bulk of assets in the trust for greater control. They were also leveraged for robust asset protection, shielding the funds from creditors and even the beneficiaries themselves.

However, this is no longer the case. Unless the beneficiary qualifies as an eligible designated beneficiary (EDB), the assets in a conduit trust are now vulnerable to claims from creditors and the beneficiary once the 10-year period has elapsed. This represents a major shift that significantly undermines the utility of conduit trusts for many estate planning purposes.

Individuals and families can no longer rely on conduit trusts as an ironclad method of protecting their wealth and legacy. Alternative trust structures and strategies must be carefully considered to ensure assets are safeguarded both during one's lifetime and for future generations.

Accumulation trusts offer a distinct advantage over conduit trusts when it comes to managing inherited IRA assets. The key difference lies in the trustee's discretion to determine whether to pay out or retain any distributions from the inherited IRA.

This flexibility is a game-changer. By allowing assets to remain in the trust, they are shielded from the reach of any outside creditors. This provides an added layer of protection that can give the IRA owner greater peace of mind when designating beneficiaries.

Equally important, the accumulation trust structure alleviates concerns about beneficiaries receiving assets too soon or in excessive amounts. The trustee can carefully manage the distributions, ensuring the inherited wealth is preserved and disbursed in a thoughtful, responsible manner. This can be particularly beneficial when dealing with young or financially inexperienced heirs.