What to Do: Estate and Special Needs Planning Under the SECURE ActBy Mark W. Worthington, JD, LLM, CELA, CAP
The SECURE Act brings major changes to retirement tax policy and basic estate planning and drafting.
What Did SECURE Do?
The SECURE Act (December 20, 2019) changed the required payout for inherited defined contribution plans (401(k)s, 403(b)s, IRAs, etc.) left to designated beneficiaries (DBs)1 from RMDs (required minimum distributions annually over the life expectancy of the DB), to an “all out by the 10th year after death” rule. We call the time period (whether lifetime or 10 years) the ADP, or “applicable distribution period.”
You still need to know all the pre-SECURE rules governing defined contribution retirement plans and naming trusts as death beneficiary of those plans, including drafting conduit trusts and accumulation trusts. That is because for the most part, SECURE layered on exceptions and definitions without repealing existing statutes and regulations.2
Why Does This Matter?
Even if we had a flat rather than progressive tax structure, (1) smaller RMDs over a longer ADP is more real after-tax net-present-value dollars for the family, and (2) SNTs need to be able to retain income in the discretion of the trustee, and retained trust income is taxed at the top federal rate of 37 percent at mere $12,950 taxable income.
What Else Did SECURE Do?
SECURE carved out exceptions to the 10-year rule. There are five types of eligible designated beneficiaries (EDBs) who continue to qualify for RMD over a life-expectancy ADP. Those are:
• Surviving spouse (who still has all the pre-SECURE options, such as a spousal rollover)
• Minor children
• Disabled (IRC §72(m)(7), not 42 USC §1382c(a)(3))
• Chronically ill (IRC §7702B with some modifications)
• A person not more than 10 years younger than the deceased plan owner
Under SECURE, the ADP is not necessarily fixed at the death of the plan owner. It can start as lifetime for an EDB, then switch to 10-year rule at the EDB’s death (or attaining age of majority). It can also start as lifetime for any DB where death was pre-2020, and then at death of the DB post-2019, it switches to 10 years.
Special SNT Rules
By themselves, the EDB exceptions provide no possibility of an accumulation SNT being able to use a life-expectancy ADP. Fortunately, SECURE as finally enacted contains two special provisions permitting qualifying SNTs to use lifetime ADPs.
1. Qualifying SNT. An SNT that benefits one or more disabled or chronically ill (DisCI) persons for their lifetimes, and no other persons during that time, qualifies to take RMDs over the life expectancy ADP.
2. ADP Separate Accounts Rule override. If A, B, and C are the death beneficiaries of retirement plan, they each get to use their separate life expectancies to compute RMDs. Under Treasury regulations, doing the same thing by passing the retirement plan through a revocable trust that splits outright to A, B, and C requires all of them to use the life expectancy of the oldest to compute RMDs. SECURE overrides this in the case where the revocable trust divides at the retirement plan owner’s death into one or more shares for SNTs, and shares for typicals (as the non-disabled are referred to in the special needs community). In that case, we only look to the SNT to determine the ADP/RMD for the SNT. However, the shares for typicals still consider the beneficiaries of all of those shares to determine ADP/RMDs.
Here’s Just Some of What We Don’t Know
• Disability Definitions and Documentation
• SECURE does not cite to Social Security disability definition and has no definition appropriate for minors with disabilities.
• What certification is adequate to establish DisCI? Is periodic recertification necessary for disability?
• Qualifying SNT Remaindermen: Do ages of remaindermen still matter? Can we name charities?
• Who is a minor?
• With a 10-year rule, must we still be able to identify the beneficiary with the shortest life expectancy where the DB is not an EDB?
The IRS is expected to issue guidance in the near future.
Planning and Drafting
Ideas abound about planning under SECURE: life insurance (no longer to pay estate tax, but to pay the accelerated income tax at higher bracket rates), charitable remainder trusts (to mimic the stretch), and separate discretionary trusts for retirement and non-retirement plan assets (to allocate the tax burden where most efficient yet still equalize benefit). But the guidance I offer here in planning and drafting is keeping within the confines of the basic estate plan.
SECURE gives powerful new impetus to Roth conversions and Roth contributions, especially where an SNT (with trust income tax rates) is the beneficiary: No RMDs during plan owner’s lifetime, post-mortem lifetime RMDs, and no taxable income when money comes out of the plan.
The good news is that while you need to understand a lot about pre- and post-SECURE law to do a good job planning, there does not seem to be much about drafting that will change.
Adult Non-EDB Beneficiaries
If these beneficiaries take outright, or via a conduit trust, or via any trust where the beneficiaries are all DBs, then you get the 10-year rule. The tradeoff between asset protection trusts for beneficiaries and punishing income tax rates is dramatically intensified.
EDB Other Than DisCI
• The only way to leave assets in trust for these beneficiaries and qualify for the life expectancy ADP is via a conduit trust.
• A conduit trust for a person not more than 10 years younger than the deceased plan owner will produce a less than 10-year ADP if they are both 81 or older.
• Most of the time, the surviving spouse will be named to take retirement plans outright as this produces the best overall tax result, even in states with an estate tax. Where there are compelling reasons to leave retirement plans in trust for the surviving spouse, not only must a conduit trust be used, but the marital deduction trust must require withdrawals and distributions of the retirement plan assets that are the greater of the RMD or the fiduciary accounting income of the retirement plan.
• A conduit trust for minor children may not be a good idea. Your client in most cases is likely to live until his/her children are no longer minors. If your client dies when the child is a minor, the life expectancy ADP only lasts until the age of majority. If that were, say, age 18, 100 percent of the plan must be distributed from the trust out to the child at age 28. If you forgo the conduit provisions, while all assets must come out of the plan within 10 years of the owner’s death, the retirement plan assets can be retained in trust for as long as desired.
If you want each child to get lifetime ADP during the child’s minority, you will need to specify the division at the death beneficiary designation level, and name each child’s subtrust under the revocable trust as beneficiary.
• Tighten up your SNT so that no one can benefit from retirement plans and retirement plan accumulations other than the initial special needs beneficiary(ies) during his/her/their lifetime. No discretionary distributions to descendants, for example. Note: You don’t need to similarly restrict trustee’s use of other assets.
• Until we have guidance or regulations from Treasury, the most conservative approach is to assume that SNT remaindermen must not merely be individuals, but all be identifiable individuals whose ages count in determining lifetime ADP. That is, you continue to draft your accumulation SNT considering the ages of the remainder beneficiaries in the same way you always have.
• Where there are shares for an SNT and shares for typical children, consider adding an allocation clause to the revocable trust first funding the SNT with a fraction (or all) of the Roth retirement plans.
Even if you are conscientious about giving each client a closing letter, it can be a real service to clients to send them a SECURE update letter. Refine your list to those who had an SNT or a conduit trust.
If you have drafted conduit trusts for clients, the result under SECURE depends on exactly how it was drafted. The result could be annual distributions from the trust for 10 years (or lifetime, if an EDB), one big distribution from the trust at year 10, or 10-year or lifetime withdrawals from the plan, but the trust may accumulate those withdrawals.
NAELA and You
You really can make a difference. The only reason SNTs were saved from the SECURE Act's 10-year rule is that a small group of volunteers on the NAELA Tax Steering Committee — people like you — realized there was a problem and drafted an issues brief that NAELA sent to the House of Representatives. When you volunteer for a committee or a project, your attributes will encounter opportunities that will produce real results.
1 A DB is an individual, or a group of individuals where we can determine the one with the shortest life expectancy as of the death of the retirement plan owner. SECURE did not change the rules where there is no DB.
2 Every practitioner should have a copy of Life and Death Planning for Retirement Benefits, 8th Ed. 2019, by Natalie B. Choate (www.ataxplan.com). A SECURE Update will be a free download for owners of the book. The author of this article has no financial interest in this book.
About the Author
Mark Worthington, CELA, CAP, Framingham, Massachusetts, is a member of the NAELA Tax Section Steering Committee. This article is provided by the Tax Section. For information on joining this section, visit www.NAELA.org/Sections.
Jeff Sodoma, MPA, Esq. is a lawyer based in Virginia Beach, Virginia
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