By Stephen R. McDonnell, Esq. On July 11, 2022, Pennsylvania passed Act 68, which limits…
By P. Kristen Bennett, Esquire –
Gawthrop Greenwood is advising workers and retirees to update their estate plans, now that the SECURE Act (Setting Every Community Up for Retirement Enhancement Act) became effective January 1, 2020. The new federal law makes a number of changes to retirement plans and IRAs that could result in dramatic tax consequences.
With a few exceptions, the SECURE Act eliminates the stretch IRA, the ability of a non-spouse beneficiary to take required minimum distributions over his or her life expectancy. Instead, the retirement plan must be distributed by December 31st of the tenth year following the plan participant’s death (the “10-year rule”). The retirement plan may be distributed in a lump sum at any time within the 10 years or distributed in equal or unequal periodic payments during the 10 years. This means your beneficiaries must pay the income tax associated with IRA distributions in a much shorter period of time and potentially at a higher rate.
Still, a stretch IRA remains an option for a surviving spouse, minor beneficiary, disabled beneficiary, chronically ill beneficiary, or for a beneficiary who is less than 10 years younger than the plan participant. Below are several of the exceptions to the 10-year rule, as well as estate planning techniques to consider with your attorney under the SECURE Act.
Naming a Spouse as Beneficiary
Under the Secure Act, the rules regarding naming a spouse have not changed significantly. A spouse named as a beneficiary may still stretch the benefits (and tax implications) over their lifetime. In addition, in most cases, a trust for the benefit of a surviving spouse may still be stretched over the spouse’s lifetime.
However, on the death of the surviving spouse, the life expectancy payout is eliminated and the remainder must be paid out to the non-spouse beneficiary according to the 10-year rule.
Naming Minor Children as Beneficiary
Minor children as beneficiaries and minor children as beneficiaries of conduit trusts, are entitled to a life expectancy payout of retirement benefits only until he or she attains the age of majority, or threshold of adulthood as determined by state law. Upon attaining majority, the benefits are then required to be paid out under the 10-year rule.
An accumulation trust for a minor child generally will not provide the life expectancy payout, regardless of the child’s age, because the minor child is not considered the sole beneficiary of the trust. An accumulation trust looks at all of the potential beneficiaries and therefore disqualifies the trust from using the minor child exception.
Under the SECURE Act, the new rules create problems for parents because neither type of trust is optimal from a control or tax planning perspective. An accumulation trust requires pay out within 10 years while a conduit trust requires payout within 10 years after the child attains the age of majority. If a parent wishes to provide benefits to young children, it may be more prudent to focus on how to pay the taxes rather than on how to defer them.
Naming a Trust as a Beneficiary
Under the new 10-year rule, conduit trusts may cause dramatic income tax consequences. Beneficiaries will have to realize income over a shorter period of time, likely resulting in higher income tax rates. Additionally, conduit trusts will no longer provide long-term control or protection of retirement benefits as previously expected. Prior to SECURE, conduit trusts minimized the income tax impact on required distributions.
Under SECURE, it may be more beneficial to name an accumulation trust as the beneficiary of a retirement account rather than a conduit trust. An accumulation trust allows the required distributions to collect inside the trust without distribution prior to the end of the 10-year payout term. The retirement account would, however, still be required to distribute the trust by the end of the 10-year term.
Active workers and retirees should be sure to review the following with their Estate Planning lawyer:
New Estate Plans
- Consider whether a potential beneficiary fits into one of the five exceptions to the 10-year payout rule.
- Leave benefits to a charitable remainder trust to eliminate the income tax on the IRA and provide a lifetime payout to individual, non-charitable beneficiaries.
- If the plan participant is in a lower tax bracket than the future beneficiary, consider lifetime Roth conversions to absorb the tax at a lower rate.
- Plan for payment of the tax. This could include buying life insurance or using a portion of the benefit distribution.
Existing Estate Plans
Be sure to revisit your estate plan with an attorney if:
- Your entire plan for retirement benefits is centered on providing a stretch payout.
- You’re leaving benefits to a conduit or accumulation trust.
- You plan on leaving retirement benefits to nondisabled and not chronically ill grandchildren.
- You have a supplemental needs trust.
If you have any questions about updating your estate plans, Kristen Bennett can be reached at email@example.com or 302-777-5353