Creative SECURE Act Planning

Take-Away: With the change in distribution rules caused by the SECURE Act, some creative ideas are being touted to circumvent the new 10-year payout rule, especially in light of the 2021 change in the Uniform Lifetime/Minimum Distribution Table. While worth considering, a trustee has to take many different variables into its decision to take taxable  IRA distributions.

Background: We have previously covered the 10-year distribution rule applicable to most inherited IRAs under the SECURE Act. However, a couple of existing distribution rules were not changed by that Act.  We have also covered those unchanged rules as well: (i) if the IRA owner dies prior to age 72 without any designated beneficiary, then the 5-year distribution rule prevails; and (ii) if the IRA owner dies after his/her required beginning date (now age 72),  then the distribution period of the inherited IRA can be over the deceased owner’s phantom life expectancy, which may be longer than the Act’s 10-year distribution rule.

Minimum Distribution Table Update: Beginning in 2021 the IRS’s updated  life expectancy tables will become effective, reflecting the longer life expectancies identified in the 2010 US Census. Under those new IRS tables, the life expectancy of an IRA owner who dies after age 72 will be longer than 10 years if he/she dies between the ages of 73 and 80. Consequently, if the goal is to continue to stretch taxable distributions from an inherited IRA for as long as possible, then the beneficiary of the inherited IRA may want to use the deceased owner’s phantom [he is dead, but we still give him a ‘life expectancy’] if the owner dies prior to age 80.

Toggling Planning Strategies: Many existing IRAs currently name a see-through trust as the IRA beneficiary, since a see-through trust will be treated as a designated beneficiary. Conduit see-through trusts will still have to take distributions of the inherited IRA and immediately distribute them to beneficiaries over the following 10 years. Accumulation see-through trusts are not required to make annual distributions to beneficiaries, but they still are subject to the requirement of taking the final withdrawal on the tenth anniversary of the IRA owner’s death.

If a trust is not treated as a see-through trust, because there is a failure to meet any of the four requirements to be treated as a see-through trust, then there will be no designated beneficiary of the decedent’s  IRA, and thus the trustee could use the phantom life expectancy of the older deceased IRA owner, if he/she was older than age 72 at the time of their death.

In short, sometimes a longer distribution period can be attained if a trust is not a see-through trust, meaning that it does not meet the definition of a designated beneficiary.

Strategy #1- Include a Charity: If a trust has a charity as one of the trust beneficiaries, then the trust normally will not qualify as a see-through trust. Example: A conventional trust established for the IRA owner’s children but it also has a provision that leaves $5,000 to a charity. The presence of the charity means that the trust does not qualify as a see-through trust. However, the trustee has until September 30 of the following year to have to identify all of the trust beneficiaries. If the charity is paid its $5,000 prior to that September 30, the trustee can ignore the charity as a named beneficiary, and thus, come September 30, the trust will not have a charity as its beneficiary, and it will ultimately qualify as a see-through trust, subject to a 10-year distribution obligation.  

As an alternative, the trustee may choose to wait until the next day (October 1) to pay the charity the $5,000. By waiting just one day, the trust will have a charity as one of its named beneficiaries on September 30, and thus it will not qualify as a see-through trust. Thus, there will be no designated beneficiary of the decedent’s IRA, which means that if the IRA owner was older than age 72 at the time of his/her death, a potentially longer period will govern distributions from the decedent’s IRA. By choosing to pay, or not pay, the charity results in either the trust being treated as a see-through trust, and subject to the 10-year distribution rule, or not qualify as a see-through trust, and thus not qualify as a designated beneficiary yet therefore eligible to use the deceased IRA owner’s potentially longer phantom life expectancy period.

To complete the example, if the IRA owner dies at age 82, then the trustee would timely cash-out the charity in order to qualify the trust as a see-through trust, with a 10-year distribution period (longer than the phantom life expectancy of an 82 year old person.)

Strategy #2- Don’t Deliver a Copy of the Trust: The second strategy almost seems like an invitation to a breach of fiduciary duty claim. One of the four conditions that is required to qualify as a see-through trust is that a copy of the trust instrument must be delivered by the trustee to the IRA custodian by October 31 of the year following the IRA owner’s death. It is a simple ministerial act, but it is necessary for the trust to be treated as a see-through trust, and thus a designated beneficiary. By not timely delivering a copy of the trust instrument to the IRA custodian, the trust fails as a see-through trust, and thus it is subject to the older deceased IRA owner’s phantom life expectancy.

Observation: While either of these two ‘toggles’ are within the trustee’s control, there is always a risk in adopting a ‘wait-and-see’ approach to exploit the deceased IRA owner’s phantom life expectancy if he/she dies between ages 72 and 80.

• Non-professional trustees might be oblivious to the technical see-through trust qualification rules, and thus not act timely to achieve the desired distribution period.
• More important is that a lot of factors enter into a decision to take taxable distributions from an inherited IRA. Trust beneficiaries may be in different tax brackets due to their own sources of income. Other assets held in the trust may also generate taxable income to be considered.

Conclusion: While presumably toggling by the trustee to achieve a longer distribution period (if the IRA owner was between ages 72 and 80 at the time of his/her death) may help achieve a mildly longer stretch distribution from the inherited IRA, there are a lot of other considerations involved beyond elongating the period of IRA distributions. Toggling might work, then again, toggling might create more problems than it is worth.