Back to Missives
George F. Bearup, J.D. Senior Legal Trust Advisor

3-Jan-20

SECURE Act V – What to Do Now

Take-Away: With most of the SECURE Act provisions becoming effective in 2020, existing estate plans and retirement plan and IRA beneficiary designation forms will need to be reviewed, particularly those estate plans that feature large IRA and 401(k) accounts. A few practical observations follow.

Acceleration of Taxable Income: Perhaps the biggest problem, by far, is the acceleration of the deferred taxable income in inherited retirement accounts, which must be recognized within ten years after the retirement account owner’s death. Not only will that income need to be recognized over a shorter period of time for most designated beneficiaries, it may be exposed to marginally higher federal income tax brackets if the beneficiary has his/her own income in the year of the IRA distribution.

  • Roth Conversions: One response to the SECURE Act will be for retirement account owners to consider a Roth IRA conversion during their lifetime. This should be considered by those IRA owners who are currently in a lower income tax bracket than they expect their beneficiaries to be (which will often be the case if the IRA is payable to an accumulation see-through ) The Roth IRA, which must also be distributed within 10 years of the Roth IRA owner’s death, will be income tax-free to the beneficiary, thus not exposing that distribution to marginally higher income tax brackets.
  • Income Tax ‘Financing:’ If traditional IRAs are paid to designated beneficiaries, those beneficiaries will face higher income taxes on the mandated IRA distributions over ten years. Individuals with very large retirement account balances, and not much other liquidity, should consider using some of their own lifetime RMD distributions to create or acquire the liquidity that will be needed by their heirs to pay the additional income tax burden that arises from the bunching of the taxable income from the IRA distributions into a short period of time. This additional liquidity might be sourced in an irrevocable life insurance trust (ILIT) or LLC owned by children where the insurance death benefit paid on the IRA owner’s death will be income tax-free, and if held in the ILIT (or LLC) also free from federal estate taxation.

10-Year Payout for Most Inherited IRAs: The loss of the stretch IRA distribution rules for many inherited IRAs is one of the biggest changes caused by the SECURE Act. That change will affect many see-through trusts that are named as IRA beneficiaries, and prompt a consideration of the needs of successor beneficiaries when the designated beneficiary dies prior to their normal life expectancy or the ten years required distribution period.

  • Review Existing Conduit See-Through Trusts: As was mentioned in prior summaries of the SECURE Act, many conduit see-through trusts have been named as IRA beneficiaries in order to protect the trust beneficiary from their own spendthrift behavior by ‘doling-out’ the taxable IRA distributions over that beneficiary’s lifetime. That purpose of the conduit see-through trust just got frustrated with the SECURE Act’s mandatory 10-year payout rule. Many conduit see-through trusts will have to be revisited and perhaps converted to an accumulation see-through trust if protection of the trust beneficiary is a material purpose of that trust.
  • Modify Conduit to Accumulation See-Through Trusts: If the conduit see-through trust is already irrevocable and receiving distributions, then that trust might be modified to a new trust, which functions as an accumulation see-through trust. The Michigan Trust Code contains provisions that permit a probate court to modify the terms of an existing trust because of ‘circumstances not anticipated by the settlor’ [MCL 700.7412(2)] and ‘to achieve the settlor’s tax objectives in a manner that is not contrary to the settlor’s probable intention.’[MCL 700.7416.]
  • Review Existing IRA Beneficiary Designations: While the existing stretch IRA distribution rules apply to eligible designated beneficiaries, such as a surviving spouse, the stretch IRA distribution rule disappears on the eligible designated beneficiary’s death, to be replaced by the 10-year payout to the successor beneficiary. If a spouse is in poor health, and thus not expected to live much longer than the IRA owner, thought should be given to the named successor beneficiary of an IRA and perhaps replace the individual successor beneficiary with an accumulation see-through trust if the successor beneficiary’s creditors are a concern.
  • ‘Divide and Conquer’ Disclaimer Planning: A spouse who will become an eligible designated beneficiary needs to be educated (well before the death of the IRA owner) to the advantages of making a partially qualified disclaimer of some of their deceased spouse’s IRA. If the couple’s children are named as contingent IRA beneficiaries, the surviving spouse can make a qualified disclaimer of a portion of the inherited IRA. That disclaimer would then move the disclaimed portion of the deceased spouse’s IRA to the couple’s children, who would then face the 10-year mandatory payout of the disclaimed IRA portion on the death of their IRA owner-parent. The portion not disclaimed by the surviving spouse would then be subject to the stretch payout rules, as the surviving spouse is an eligible designated beneficiary. The qualified disclaimer by the surviving spouse will have the effect of reducing, indirectly, the taxable income that the children must begin to report over the next 10 years following the death of their parent. When the surviving spouse subsequently dies, the children, who presumably will be the surviving parent’s primary IRA beneficiaries, will start a second 10-year payout period with regard to the portion of the initial IRA that was not disclaimed by the surviving spouse. This approach enables (hopefully) the children to spread distributions from the decedent’s IRA over a period of up to 20 years, 10 years after the death of their first parent to die, and another 10 years after the death of the second parent to die.
  • 2019 Death Planning: If an IRA owner died in 2019, it may make sense for the primary beneficiary of the decedent’s IRA to make a disclaimer of a portion of that inherited IRA. The new 10-year payout rule only applies to IRA owners who die after December 31, 2019.
    • Example: Frank died on July 1, 2019. Frank’s wife, Mary, is named as the beneficiary of Frank’s IRA. Mary is an eligible designated beneficiary who can roll Frank’s IRA into her own IRA, and since Mary is over age 70 ½, her required minimum distributions can be stretched over her life expectancy. Frank’s two children, Bob and Denise, are named as the contingent beneficiaries of Frank’s IRA. Mary has 9 months from the date of Frank’s death to disclaim some, all, or none, of Frank’s IRA. If Mary disclaims a portion of Frank’s IRA prior to April 1, 2020 (within 9 months of Frank’s death), the portion of Frank’s IRA that was disclaimed by Mary will pass to Bob and Denise in shares of equal value. Bob and Denise will be treated as the named designated beneficiaries of the disclaimed portion of Frank’s IRA. Bob and Denise will be treated as beneficiaries of the IRA relating back to the date of Frank’s death, or July 1, 2019. As a result of Mary’s qualified disclaimer of a portion of Frank’s IRA, Bob and Denise will be able to take stretch IRA distributions from their inherited IRA (from Frank) over their respective life expectancies, not the required 10-year payout that applies to inherited IRAs after December 31, 2019. When Mary dies long after 2019, what is left in Mary’s IRA will be distributed to Bob and Denise who will have to take distributions from Mary’s IRA over ten years. The result is to first expose part of Frank’s IRA to the existing stretch distribution rules over Bob and Denise’s respective life expectancies, both of which will be longer than 10 years. In addition, through Mary’s disclaimer, when Bob and Denise ultimately inherit the balance of Mary’s IRA, there will be a smaller amount that they will have to report as taxable income over the 10 years after Mary’s death, i.e. there will be less bunching of that taxable income in a short period.

Conclusion: When the IRS gets around to updating its Regulations to reflect the SECURE Act’s changes, hopefully, there will be other practical planning opportunities that surface. For the time being, most trusts that are intended IRA and 401(k) beneficiaries will need to be reviewed with clients to confirm that their intent will not be frustrated by the SECURE Act’s mandatory 10-year payout rule for all designated beneficiaries.