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George F. Bearup, J.D. Senior Legal Trust Advisor

24-Sep-19

The SECURE Act’s Impact on “See-Through” Trusts

Take-Away: If the SECURE Act becomes the law, required minimum distributions (RMDs) from inherited IRAs and qualified plan accounts will be dramatically curtailed, going from distributions over the beneficiary’s life expectancy to only ten years. While the proposed law would exempt disabled beneficiaries from the mandatory 10-year payout from the retirement account, those disabled beneficiaries will nonetheless be disadvantaged if the retirement plan distributions are made to a ‘see-through’ trust where there are multiple beneficiaries of the same trust.

Background: Last May the House of Representatives passed the SECURE Act on a vote of 417 to 3. The Bill is now before the Senate Finance Committee. There is a strong likelihood that the SECURE Act has bipartisan support and it will be adopted and become the law before the end of this calendar year. IRC 401(a)(9) would be amended by the SECURE Act to require that post-death distributions from a retirement account to a beneficiary [exceptions noted below] must be made over a flat 10-year period, not over the designated beneficiary’s life expectancy, which is the existing rule with regard to RMDs. This 10-year payout rule would apply beginning on 1/1/2020. To date, there has been no discussion, at least at the Senate level, in ‘grandfathering’ existing inherited IRAs that exploit the stretch IRA rules.

SECURE Act Exceptions- Designated Eligible Beneficiaries: Excepted from the mandatory 10-year payout of retirement plan benefits are: (i) surviving spouses; (ii) minor children of the account owner; (iii) persons not more than 10 years younger than the deceased IRA or qualified plan participant; and (iv) individuals with disabilities and those with chronic illness. These four exceptions are referred to an Eligible Designated Beneficiaries, who are permitted to take distributions over the exception-beneficiary’s life expectancy. The exceptions appear to be reasonable. However, they will not be available when there are multiple beneficiaries of the same see-through trust once the SECURE Act becomes law.

‘See-Through’ Trust Rules: While a trust is not an ‘individual,’ current Treasury Regulations will ignore the trust as the named beneficiary of an IRA or qualified plan account and ‘see-through’ the beneficiary-trust to its individual beneficiaries, but only if those beneficiaries are identifiable.[Treas. Regulation 1.401(a)(9)-4(A)(1).] Identifiable means the individual [trust beneficiary] with the shortest life expectancy who can receive a distribution from the qualified plan or IRA. Consequently, if all of the individual trust beneficiaries are identifiable, then the retirement plan account or IRA will be treated as having ‘designated beneficiaries’ and the trust, while  technically named as the retirement plan beneficiary, will qualify as a see-through trust in order to use the life expectancy payout RMD for the oldest identified trust beneficiary. Identifying that oldest trust beneficiary then dictated the required minimum distribution amounts that the see-through trustee had to withdraw from the IRA or qualified plan account.

Continuing Trusts as ‘See-Through’ Trusts: Only two forms of a continuing trust can meet the see-through trust requirements under existing Treasury Regulations.

  • Conduit: A conduit trust requires all withdrawals from the retirement account to be immediately distributed by the trustee to the current trust beneficiaries. All designated beneficiaries who are only current lifetime beneficiaries immediately upon the death of the retirement account owner are considered, so that the oldest current lifetime beneficiary’s life expectancy is used to determine the RMD payout from the retirement account. Restated, the oldest current lifetime beneficiary, with the shortest life expectancy, will control the required minimum distribution from the retirement account paid to the see-through, and then from the see-through conduit trust to and among the current lifetime beneficiaries.
  • Accumulation: With an accumulation trust, the life expectancy of all trust beneficiaries, not just the current lifetime beneficiaries but also the life expectancies of all trust beneficiaries who could take accumulated withdrawals after the death of the current lifetime beneficiaries, i.e. which thus includes all remainder trust beneficiaries, must be taken into consideration to identify the trust beneficiary with the shortest life expectancy, which in turn then controls the required minimum distribution the trustee must take from the retirement account and held (or distributed) from the see-through accumulation trust.

Impact of SECURE Act on ‘See-Through’ Trusts: The practical application of the 10-year payout obligation when there is an exception beneficiary of the trust under the SECURE Act might be the following.

  • Disabled Trust Beneficiaries: Consider a disabled individual for whom a trust is created. A disabled individual is usually unable to manage his/her own affairs, which accordingly requires the use of a trustee to handle the finances on behalf of the individual. Since many disabled individuals are dependent upon means-tested public benefits, the continuing trust created for a disabled individual is usually a special needs trust that will not be treated as a ‘countable resource’ used to determine if the disabled beneficiary qualifies for governmental financial assistance. As a result, most trusts established for a disabled individual are accumulation trusts, e. no mandatory distributions of retirement plan distributions to current trust beneficiary, who is usually the disabled individual. However, with an accumulation trust, the life expectancy of all trust beneficiaries, not just the current lifetime disabled trust beneficiary, is considered to determine required minimum distributions from a qualified plan or IRA to the see-through trust. Consequently, since remainder trust beneficiaries will probably not be disabled, under the SECURE Act, the pool of designated beneficiaries will include non-disabled individuals. In short, a special needs trust will not qualify for the post-death exception-beneficiary life expectancy payout rule that would otherwise be available for a disabled individual under the SECURE Act. Solution: It is hard to envision a good solution to this problem.  The continuing trust created for a disable person needs to be an accumulation trust in order to maintain the disabled beneficiary’s eligibility to continue to receive governmental benefits. However, that then means that there will be remainder beneficiaries of the trust who are not disabled, which then forces the 10-year SECURE Act payout to apply even though a disabled individual is the intended current beneficiary of the see-through accumulation trust.
  • Surviving Spouse Trust Beneficiary: Consider a conventional credit shelter trust in a blended family situation that is funded on the retirement account owner’s death, where the beneficiaries of the credit shelter trust are the decedent’s surviving spouse and the deceased spouse’s children from a prior marriage. In this situation, even if the trust is structured as a conduit trust, the separate accounts rule will not apply. [Treas. Regulation 1.401(a) (9)-4(A5) (a) &-4(A5) (b) (3).] The separate accounts rule provides that a retirement plan that is divided among multiple beneficiaries at the plan beneficiary designation level is permitted to compute post-death required minimum distributions separately for each beneficiary’s share, based upon each beneficiary’s own age. However, if the retirement plan names a trust as its sole beneficiary, the trust must use the oldest trust beneficiary’s life expectancy, even when the trust is to split immediately into separate subtrusts for multiple beneficiaries at the death of the retirement account owner. [Treas. Reg. 1.401(a) (9)4 (A5) (c).] With a see-through conduit trust, all current lifetime beneficiaries must be accounted for to determine the application of the required minimum distribution rules. Because there would be multiple beneficiaries under the credit shelter trust, i.e. a surviving spouse and children of the settlor, SECURE Act’s ten-year mandatory payout rule will apply to the conduit trust rather than the life expectancy of the surviving spouse. Solution: Rather than use a spray trust, where the trustee possess discretion to spray trust income among multiple beneficiaries, the credit shelter trust should only permit distributions to the surviving spouse, but that may also mean that part of the decedent’s estate would be diverted from the credit shelter trust into a separate trust for the decedent’s children, if the goal is to have them eligible to receive distributions while their step-parent is the lifetime beneficiary of the credit shelter trust. As is always the case, remember that the division of a retirement account into multiple subtrusts needs to be accomplished in the beneficiary designation where separate shares are created, not in the trust instrument that divides its assets into multiple shares.
  • Minor Children Trust Beneficiaries: Consider the conventional ‘pot trust’ that is used when parents die, which is used to hold their wealth until their children are old enough to competently manage their inheritances. Normally a single trust is used which is not split into subtrusts until the youngest child graduates from college or attains age 23 years (or some other age.) Because a single ‘pot trust’ is used, the separate accounts rule for required minimum distributions, described above, will not apply. Under the SECURE Act, the single trust established for all young children, or even separate subtrusts for each child under the same trust instrument, will qualify as an Eligible Designated Beneficiary, but only so long as all of the children-trust beneficiaries are under age 18. However, as soon as the oldest child attains age 18, even if the trusts are separate trusts established under the deceased parent’s revocable trust, the SECURE Act’s exception for Eligible Designated Beneficiary ceases.
    • Example: Parents have three children 13, 8 and 3 years of age. A trust is named as the beneficiary of the deceased parent’s retirement account; each of the children are beneficiaries under that single ‘pot trust.’ The life expectancy of the oldest child will control the required minimum distributions from the retirement account until the oldest child attains age 18 years. When the oldest child reaches age 18 years, even though the other children will then be ages 13 and 8, the trust will no longer have an Eligible Designated Beneficiary (the oldest child will no longer be under age 18.) Consequently, the final retirement plan payout (after 10 years) will occur when the youngest child-beneficiary is merely 18 years old. Solution: The separate share rule should be used, with each subtrust named as the beneficiary of a pro-rata portion of the retirement account, at the beneficiary designation level, rather than naming the ‘pot trust’ as the sole beneficiary of the parent’s retirement account and relying on the trust instrument to divide trust assets into separate shares, one for each child. That way the mandatory 10-year payout will apply to each child, not when the oldest child attains age 18 years.

Conclusion: It is possible that when the SECURE Act finally becomes law, some of these perceived concerns will be addressed, especially for disabled trust beneficiaries. However, using one trust for multiple beneficiaries arguably presents problems and possibly could preclude exploiting designated eligible beneficiaries opportunity to continue to stretch taxable distributions from an IRA or retirement account.