It’s been a long hiatus, but Weekly Scenario is back.
For the first issue, I thought I would write about the SECURE Act and planning with retirement accounts and trusts.
The SECURE Act went into effect at the beginning of last year and has significantly impacted both retirement planning and estate planning.
The main way the SECURE Act may impact a trust is with the termination of “stretch” distributions of inherited retirement accounts. Previously, clients planned on passing on significant qualified retirement accounts because they could grow tax-deferred, or in some cases, tax-free. Their beneficiaries would inherit the funds, set up their own inherited retirement account, and were given the option of withdrawing all of the money in the account immediately, within 5 years, or stretching it over their lifetimes based on their projected life expectancy.
A prudent person could plan to stretch the distributions out over his or her lifetime in order to minimize the impact upon his or her income tax.
Now, however, beneficiaries cannot stretch out their inherited retirement account distributions over their lifetime – it must be done within 10 years (other than with some limited exceptions).
As a result, this likely will substantially increase the beneficiaries’ tax rate and the overall amount of income tax paid on the inherited money. Depending upon the size of the retirement account, some beneficiaries could be looking at the loss of tens of thousands, even hundreds of thousands of dollars in taxes.
Many clients are now working with their advisors to rely upon other vehicles of passing on their wealth instead of relying upon qualified retirement plans – such as life insurance or non-qualified retirement plans. Other clients are re-considering what beneficiary designations on those accounts should be –based on their beneficiaries’ income tax rates.
On the estate planning side, language in trusts and Wills which references stretch IRAs, lifetime distributions, and the age for required minimum distributions should be re-evaluated.
Another way the SECURE Act may impact a trust is potentially switching from a “conduit” trust for qualified retirement plan proceeds to a so called “accumulation” trust. Previously, when IRA distributions could be stretched out over a beneficiary’s lifetime, a conduit trust was a popular choice to name as the beneficiary of that account. That way the trustee would receive payouts on behalf of a beneficiary like a minor child or young adult and immediately use it for the benefit of that beneficiary, while still using the beneficiary’s income tax rate. The account for the most part stayed out of the beneficiary’s hands directly, and there was preferred tax treatment.
Now, however, since an account must be withdrawn within 10 years, the distributions for minor children or other beneficiaries are significantly higher since the account isn’t stretched over their lifetime. A conduit trust where a smaller amount is withdrawn over time isn’t as much a problem, but kicking out 10% or more of the account over 10 years is more problematic.
Comment: Now, instead of forcing the Trustee to pay an excessive amount of money out for the benefit of the child, it may be more prudent to retain it in trust for later in the child’s life. This incurs a higher tax rate, but ultimately ensures that the property will remain in trust for many more years (even for life) and not just ten years.
ABOUT STEVE SHANE
Steve Shane provides strategic counseling to clients in need of estate administration, charitable giving and business continuity planning while minimizing estate, gift, and generation-skipping transfer tax exposure. He offers legal guidance to clients on asset protection and the proper disposition of assets in accordance with the client’s objectives, while employing tax planning techniques such as the use of irrevocable trusts, life insurance planning, lifetime gifts, and a charitable trust. He is also experienced with drafting documents for business planning, the incorporation, and application for exemption for Private Foundations and the administration of decedents’ estates.
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