Review Your Estate Planning in Light of the SECURE Act Regulations
March 17, 2022
- In late February, the IRS issued proposed regulations governing the required minimum distributions from qualified retirement plans as modified by the SECURE Act.
- The SECURE Act changed the distribution period for certain beneficiaries.
- The Act firmly sets the age of majority at 21 for beneficiaries of IRAs and other defined contribution plans.
- Proposed changes for chronically ill or disabled beneficiaries should trigger a reassessment of special needs trusts.
- Everyone should revisit their estate plan and beneficiary designations in the context of IRA and defined contribution plan distributions to make sure that the planning still makes sense.
On December 20, 2019, the SECURE Act was signed into law. In addition to making other changes to retirement plans and IRAs, the SECURE Act changed the rules on distributions from defined contribution plans, including IRAs, for deaths that would occur after December 31, 2019.
On February 24, 2022, the Internal Revenue Service issued proposed regulations relating to the required minimum distributions from qualified retirement plans as modified by the SECURE Act (“Proposed Regulations”).
In 2020, we issued a newsletter on the changes made by the SECURE Act. At that time, the new law seemed fairly clear, but there were still some unanswered questions. The Proposed Regulations have provided us insight to many of the unanswered questions that we had about the SECURE Act. However, these regulations have also given us some surprises about the IRS’s interpretation of the SECURE Act.
The purpose of this newsletter is to revisit the changes made by the SECURE Act and to summarize some of the key provisions of the Proposed Regulations. Our hope is that this newsletter will encourage the reader to revisit their estate plan to properly address qualified retirement plan benefits. This is especially important if a trust(s) is named as the primary or contingent beneficiary of these benefits.
Stretch IRA Eliminated
Under the rules prior to the SECURE Act (“old rules”) and with proper planning, the life expectancy of the IRA beneficiary could generally be utilized to determine the minimum distribution requirements that apply after the death of the IRA owner. So, for example, if the beneficiary of an IRA is 35, under the old rules, distributions from the IRA could be taken out annually over 50.5 years. This dynamic distribution option has often been referred to as “Stretch IRAs.”
The SECURE Act changed these rules for deaths occurring after December 31, 2019 (“new rules”). Essentially, the Stretch IRA rules ( with some exceptions) are replaced with a rule that requires that the IRA be distributed in its entirety to the designated beneficiary by the end of the tenth (10 th) year following the year of death of the IRA owner (“10-year rule”).
Even with the new rules, it is still necessary to determine that the beneficiary be a “designated beneficiary.” Like the old rules, if the beneficiary of an IRA does not qualify as a “designated beneficiary,” then the Stretch IRA rules (under the old rules) and the 10-year rule (under the new rules) may not apply, requiring that distributions be made on an even more accelerated basis. For example, the IRA owner’s estate or a charity would not qualify as a “designated beneficiary.” This determination can be quite challenging when a trust is named as the beneficiary and there are contingent beneficiaries that do not qualify as “designated beneficiaries.”
Exception to the New Rules
There are five (5) classes of beneficiaries that give rise to an exception to the new 10-year rule. These five classes are referred to in the SECURE Act as “eligible designated beneficiaries.” If the IRA is payable to an eligible designated beneficiary, then generally the old rules and the life expectancy opportunities are still available. Eligible designated beneficiaries include surviving spouses, children (as opposed to step-children or grandchildren) of the IRA owner who have not reached the age of majority, disabled individuals, the chronically ill, and beneficiaries that are not more than ten years younger than the IRA owner.
Key Provisions Coming out of the Proposed Regulations
Some of the key provisions coming out of the proposed regulations are as follows:
- Changes to the Age of Majority. Prior to these proposed regulations, we had reliable support in the regulations for the proposition that the age of majority might be age 26 if the child was still pursuing his or her college education. This would have allowed a minor child’s life expectancy to be used until the child reaches age 26, with the 10-year rule kicking in thereafter. The IRS has nixed this idea for defined contribution plans and IRAs (still allowing defined benefit plans to use the more liberal definition) with a proposal that a child will be deemed to reach the age of majority upon attaining age 21.
- Changes to Timing re: Disabled or Chronically Ill Beneficiaries. The proposed regulations provide us with the rules for determining and timely reporting if a beneficiary is disabled or chronically ill. In this regard, the IRS confirmed that the determination is made at the time of the IRA owner’s death and such determination must be reported to the custodian or administrator by October 31 of the calendar year following the year of the owner’s death. Accordingly, the IRS proposes that if a minor child was not disabled at the time of the IRA owner’s death, but were to become disabled after the owner’s death, the child would not be an eligible designated beneficiary after attaining age 21. Further, the IRS also proposes that if a minor child or spouse of the IRA owner is disabled or chronically ill at the time of the owner’s death, compliance with the timely reporting requirements is still necessary even though their status as a minor child or spouse standing alone makes them an eligible designated beneficiary. This is important for the minor child in order to continue to make payments using the child’s life expectancy after the child attains age 21. This is important for the spouse as it relates to the multiple beneficiary rules discussed in item 3, below.
- Underscoring the Value of Special Needs Trust Planning. The IRS proposes that, if a trust provides that during the lifetime of a chronically ill or disabled beneficiary only that beneficiary may be the recipient of qualified plan benefits, then the life expectancy of that beneficiary may be used to stretch out distributions from the IRA to the trust, notwithstanding that other beneficiaries may stand to take any benefits that were accumulated in the trust during the lifetime of the chronically ill or disabled beneficiary. This may prove to be very helpful in the context of any Special Needs trust planning, although the IRS is still a bit hesitant to pull the trigger on this rule if the trust may be terminated during the disabled beneficiary’s lifetime due to any “poison pill” provision of any such trust.
- Mandatory Minimum Distributions during 10-Year Period. Much to our surprise, the IRS has proposed that even if the 10-year rule applies in a particular situation, during years one through nine, minimum distributions based on the beneficiary’s life expectancy must be taken. Prior to this proclamation by the IRS, the tax community had good reason to believe (based on a reasonable reading of the SECURE Act) that no distributions were required during the 10-year period and that it would be OK to wait until the end of the 10-year period before taking any distributions.
New Estate Planning Challenges
Through the SECURE Act, a client’s estate plan that maximizes estate and income tax savings while attending appropriately to the family dynamics with controlled and managed distributions may have been turned on its head. Many clients have already modified their estate plans after the SECURE Act, especially where “conduit trusts’ (further discussed below) were named as beneficiary of their IRAs and qualified retirement plan benefits. In many of these cases, it was still desirable for a trust to be named as beneficiary for estate tax, creditor protection, and disposition objectives; however, because the new 10-year rule applied to their situation, the “conduit trust” provisions were found to no longer be appropriate or helpful. Rather, it may have been determined that it was more appropriate to allow the IRA distributions to accumulate inside the trust, even after due regard to the compressed income tax rates that apply to trust income.
Some situations did not require any changes to the estate plan, even though the new law will require accelerated distributions from IRAs. Simply put, because the 10-year rule transplants the Stretch IRA rules, in many cases, distributions from IRAs will need to be made more rapidly than previously anticipated and the associated income taxes will need to be paid when distributed. Acknowledging this and planning for this is still necessary, even if no changes are actually made to the current estate planning documents and beneficiary designations. For example, it may be appropriate to consider the purchase of life insurance to deal with the accelerated income taxes associated with the accelerated distributions.
As stated above, many clients have trusts in place for their younger beneficiaries that have “conduit” provisions. The conduit provisions simply state that any distribution from an IRA must be distributed to the beneficiary. Under the old rules, the beneficiary’s life expectancy governed the minimum distributions. Therefore, having the distributions from the IRA be paid to the trust only to be paid to the beneficiary made not only good income tax sense, but also made good people sense, especially considering that the trustee could always accelerate the distributions from the IRA. With the new rules, generally, unless the only beneficiary of the trust is a minor child or a spouse or unless the beneficiary is otherwise an “eligible designated beneficiary,” all of the IRA assets must be distributed to the trust by the end of the tenth year following the death of the IRA owner. And, if the conduit provisions remain in place, then all these monies in turn must be distributed to the very young beneficiary and income taxes (unless a Roth IRA) must be paid on what could be a huge sum of money. Even if the beneficiary of the conduit trust is a minor child (or otherwise an “eligible designated beneficiary” that can use his or her life expectancy for distribution purposes) once the child attains the age of majority, the 10-year rule kicks in.
So, where it is still desirable for a trust to be named as beneficiary for estate tax, creditor protection and disposition objectives, the “conduit trust” provisions may no longer be appropriate or helpful. Rather, it may be more appropriate to allow the IRA distributions to accumulate inside the trust. This accumulation structure worked very well when we were under the impression that the trustee was in charge of when to take distributions on a yearly basis subject to the 10-year rule and the trustee could accelerate distributions, if desired, without restrictions. However, as stated above, the Proposed Regulations would appear to require that minimum distributions be made even if the 10-year rule applies. This does not likely make the accumulation trust the wrong choice, but it may tie the trustee’s hands from the perspective of maximizing creditor protection and accumulation.
There are too many working parts to these old and new rules to describe them all in detail in this newsletter. Suffice it to say that everyone should revisit their estate plan and beneficiary designations in the context of IRA and defined contribution plan distributions to make sure that the planning still makes sense. In some scenarios, no changes may be necessary. In other scenarios, changes will obviously be needed in light of the SECURE Act standing alone. In other scenarios, changes might be made to make the plan better than it is today, even if the general structure is retained. Even if the reader has already revisited their estate planning because of the SECURE Act, it behooves the reader to take another look in light of the good and the bad that comes out of the Proposed Regulations.
Tom Sigmund chairs Kegler Brown’s Employee Benefits & ERISA practice, and is working with clients in reviewing their estate planning strategies in light of the proposed regulations. He can be reached directly at [email protected] or (614) 462-5462.