How Will The SECURE ACT Impact Your Estate Plan?

My Comments: This Act, signed by President Trump this past December, included several important additions and modifications to existing retirement planning code sections.

For example, it changed the age when you MUST start taking money out of your income tax deferred retirement accounts. It gave retirement plan providers the opportunity to include annuities in their choice of ‘investment’ alternatives for plan participants.

What are less well known and not yet fully understood are the changes that will happen after you die. The title above implies there are significant changes that will influence how you designate what happens to your money after you die and how your beneficiaries will have access to it.

Today, January 29th, I received the following from the law firm of John J. Giamarco, J.D.,LL.M. I’ve been on his mailing list for many years and have always welcomed his insights and thoughts when it comes to trusts and estate planning issues.

This is the entire text of his newsletter:

President Trump signed the SECURE Act last December as part of the government’s spending bill and it will inevitably affect most retirement plan and IRA participants, for better or worse. The SECURE legislation — which stands for “Setting Every Community Up for Retirement Enhancement” — puts in to place numerous new provisions affecting retirement plans (such as a 401(k) plans) and IRAs. This letter summarizes some of the key aspects of the SECURE Act that may affect you and your estate plan.

Changes Affecting You During Life

One component of the SECURE Act that will affect many people during their lives is a change in the age at which a person must begin taking distributions from a retirement plan or IRA. Under the law prior to the SECURE Act, most people (with the exception of some who are not yet retired) were required to begin taking distributions from their retirement plans or traditional (non-Roth) IRAs by April 1 of the year following the year in which they reached age 70 ½. Under the SECURE Act, the age is increased to 72 for those who had not yet reached age 70 ½ in 2019. In addition, the SECURE Act removes the age cap for funding traditional (non-Roth) IRAs, meaning that individuals over age 70 ½ are now eligible to make contributions to a traditional IRA.

After Your Death

The good news is that the SECURE Act does not change the method of designating a beneficiary or beneficiaries to receive inherited retirement assets. If you have existing beneficiary designations in place, those designations are still valid. What the SECURE Act does, however, is introduce a host of new considerations that must be taken in to account in structuring your estate plan to maximize the benefit of the retirement assets and best protect your beneficiaries if you have named a trust as a beneficiary.

Perhaps the most significant changes brought about by the SECURE Act, at least in terms of estate planning, relate to how your retirement plan or IRA is distributed and taxed after your death. Under the rules prior to January 1 of this year, it was possible to stretch the distribution of inherited retirement plan or IRA assets over the life expectancy of a beneficiary, if that beneficiary met the requirements of a “designated beneficiary” under the law. The rules also permitted this advantage for retirement assets left in trust, as long as the trust was structured to meet certain requirements.

The SECURE Act has changed these rules, so that most designated beneficiaries will be required to receive the full amount of an inherited retirement plan or IRA within 10 years of the death of the person who funded the retirement plan or IRA. Certain eligible designated beneficiaries (EDBs), including your surviving spouse, your minor children (but not grandchildren), and beneficiaries who are disabled or chronically ill, are still permitted to take distributions over their life expectancies – though children who are minors at the time of inheritance must now take the full distribution within 10 years after reaching the legal age of adulthood (age 18 in Michigan).

Accordingly, estate plans that, through the end of 2019, offered a sound approach to planning for retirement assets, may no longer provide a good solution. Often participants leave retirement benefits to a trust for the benefit of their loved ones rather than naming the beneficiaries directly. The most common reasons for doing so are to control the disposition of the funds, provide credit or protection for the beneficiaries, ensure that a beneficiary will not withdraw the entire account at once, and/or plan for the possibility that a beneficiary may die prematurely. Because the payout period for most trusts has changed dramatically under the SECURE Act, naming a trust as beneficiary of retirement accounts may now produce unexpected results that are inconsistent with the participant’s original reasons for naming a trust as beneficiary.

For example, if you have named your Living Trust as the beneficiary or contingent beneficiary of your retirement plan or IRA, it is going to be held in what is known as a “conduit trust.” Any retirement assets paid to a conduit trust will pass immediately from the trustee to the beneficiary. Under the old law, that may have been a good solution in some situations, because the distributions would be stretched over the life expectancy of the trust beneficiary. However, under the SECURE Act, that same conduit trust may now require distribution of the retirement assets to the beneficiary within 10 years of the death of the plan participant or by the 10th anniversary of a minor child’s reaching adulthood. Unlike the life expectancy payout, there is no requirement of annual distributions. The distributions can be made at any time during the 10-year period as long as the plan is totally distributed by the end of the period. Depending on the circumstances, other planning techniques may better serve the goals those plans are meant to achieve, given the new rules.

Under existing rules, therefore, leaving retirement benefits in trust for the benefit of minor children is difficult without either accelerating the taxation of the benefits or accelerating the children’s control over the plan. As discussed above, a conduit trust for a minor child is entitled to the life expectancy payout, because the child is considered the “sole designated beneficiary” of the retirement plan or IRA. However, this entitlement does not last for the child’s entire life—only until he/she reaches majority, at which point the trust becomes subject to the 10-year rule. Thus, all benefits would have to be distributed outright to the minor within 10 years after he/she attained majority, which may or may not be what the parents would want.

The alternative to a conduit trust is an “accumulation trust.” An accumulation trust for a child enables the parents, through their chosen trustee, to control the funds until the child reaches a more mature age. However, an accumulation trust would not be an eligible designated beneficiary because the minor child is not considered the sole beneficiary of the trust, even if he/she is the sole lifetime beneficiary. Thus, an accumulation trust would have to cash out the retirement plan or IRA within 10 years after the parent’s death, causing an accelerated tax bill at high trust income tax rates (a trust hits the highest tax bracket at only $12,950 of income, compared to $622,050 for married couples and $518,400 for single persons).

Many parents (and others seeking to benefit young children) will face this planning dilemma: They do not want to give control to a very young child, but distributions taxable to an accumulation trust will pay the highest possible income tax rate. The conduit trust (formerly a solution to this dilemma, due to its guaranteed designated beneficiary status and its small required minimum distributions during the beneficiary’s youth) is no longer available to solve this problem except for minor children of the participant – if the participant is willing to accept a full payout 10 years after the child’s attaining majority (which would be age 28). Realistically, in most cases those seeking to benefit very young beneficiaries may have to focus more on how to pay the taxes rather than on how to defer them.

Life Insurance

Life insurance just became more valuable as a result of the SECURE Act, especially for participants who wish to leave their funds in trust to keep them protected for their beneficiaries. Since beneficiaries are now required to take Inherited IRA withdrawals over ten years and pay much more tax as a result, the ability to leave tax-free life insurance proceeds instead may create a meaningful tax arbitrage opportunity. Here’s how a strategy like this may work: you would take annual withdrawals from your IRA (to the extent permitted without penalty), pay taxes on the withdrawals, then use the net proceeds to purchase a permanent cash value life insurance policy. At your death, the death proceeds pass on tax-free money to your heirs instead of tax-deferred IRA money. Thus, rather than your heirs having to withdraw IRA money over ten years (and paying tax on it on top of their other income) they now have the full value of the tax-free life insurance policy payout.

If a trust is desired for post-death control and credit or/divorce protection, the life insurance can be payable to a trust. Life insurance is a much more flexible asset to leave to a trust. Life insurance can be retained in the trust for the beneficiary or paid out over time, simulating the best parts of the stretch IRA, but without all the tax and trust drafting complications, and there are no required minimum distributions or complex tax rules to worry about. And if the policy is owned by an irrevocable trust, the death proceeds are both income and estate tax free.

Life insurance can be used as a hedge against an untimely death that may reduce the benefits of a Roth conversion. Life insurance can also be used to replace lost retirement plan growth. The larger taxable IRA distributions which now must be made over a shorter term can be used to fund life insurance premiums as a way to replace assets. This strategy may be very effective for individuals who have large required minimum distributions at high tax rates and may be subject to estate tax.

For charitably inclined participants, it might make sense to leave your retirement plan or traditional (non-Roth) IRA to a charity (or to a charitable remainder trust) and purchase life insurance for your heirs to “replace” the wealth going to charity and to maximize legacy benefits. This way, the charity won’t pay any taxes on the distributions from the IRA and your heirs won’t pay any taxes when they receive the death benefit .

Finally, if you have existing life insurance policies that you were considering surrendering or allowing to lapse, you may now want to repurpose those policies to accomplish some of the objectives described above.

Take Action

The SECURE Act may have significant effects on your estate plan for a number of reasons. IRA assets will not be allowed to grow in a tax-free environment for as long, thus decreasing the overall value of inheritances. And younger taxpayers may be forced into higher tax brackets due to the larger amount of taxable income they are forced to report over the (shorter) 10-year period. These new provisions will result in significantly higher tax burdens for some taxpayers. Without seeing the “numbers”, plan participants may not appreciate the “gravity” of the situation or, on the other hand, may gain greater comfort that it is not worth the time, money and effort to change their existing plan.

There is an additional bonus for Roth conversions related to the SECURE Act. Although inherited Roth IRAs will be subject to the new distribution rules, since the distributions are tax-free, Roth conversions avoid the punitive high tax rates beneficiaries may encounter with traditional IRA accounts – rates that could cut the net distributions of an inherited traditional IRA in half. There is also the opportunity to use an accumulation trust to hold tax-free Roth distributions in trust for generations – something that might be too costly to do with a traditional IRA as discussed above.

In closing, confirm who is named as beneficiary and contingent beneficiary of your retirement plans and IRAs . If you have named only individuals as beneficiaries, no further action is likely required. If a trust is the named beneficiary, consider your reasons for naming the trust and contact us to determine if your goals can still be accomplished as intended. And if someone who died recently left you retirement plan or IRA benefits, there may be an opportunity to change the beneficiary by “disclaiming” those benefits within nine months of the account owner’ s death. This could be used to take advantage of the stretch IRA in certain circumstances.