Is Your Estate Plan at Risk? New Retirement Rules Mean It Probably Needs Revisions

03.04.2020 - Anna Soliman, Trust Counsel

What if, with the stroke of a pen, the estate plan of everyone with a retirement account suddenly changed. In essence, that’s what happened when the SECURE Act was approved and signed into law last December.

If you named individuals as beneficiaries of your retirement accounts, they will likely now receive those assets much more quickly—and with a heavier tax burden—than they would have under the old retirement laws. And if you named a trust as beneficiary of your IRA, the wording of that trust document could wreak havoc on your estate plan if it’s not updated to account for the new rules.

In either case, now is the time to work with your advisors to understand what will happen to your retirement accounts under the SECURE Act and make sure the proper beneficiary designations are in place.

If you named individuals as beneficiaries of your IRA

Under previous retirement account rules, people often named their children or other individuals as beneficiaries of their IRAs based on the assumption that those beneficiaries would be able to stretch the minimum required distributions over the course of their lives and defer the income taxes resulting from those distributions over their lifetime as well. This approach was referred to as the “Stretch IRA.”

But under the SECURE Act, stretching IRA distributions in this manner is no longer possible. Instead, retirement assets generally must be distributed from the account within 10 years of the owner’s death; with exceptions for beneficiaries such as surviving spouses, minor children (but not grandchildren or more remote descendants) and disabled or chronically ill individuals. And along with those accelerated distributions comes accelerated tax burdens. So, unless you engage in proactive planning now, the new law likely means your beneficiaries could ultimately end up receiving less money than they would have before the law changed.

More specifically:

  • Beneficiaries will receive retirement account assets in 10 years without any built-in incentive to preserve them for the long term.
  • More assets withdrawn in a shorter period could mean they are taxed at higher rates.
  • Beneficiaries may lack guidance on how to manage distributions within the 10-year period in a manner that minimizes taxes and maximizes their benefit.
Consider naming a trust instead

A way to address these concerns is to leave your retirement accounts to an updated, post-SECURE Act trust instead of individuals. While trusts are also subject to the 10-year distribution requirement, the trust can withdraw funds from the retirement account per IRA rules and direct the assets to be held in trust for as long as the trust specifies. Your trust will state exactly how and when you want the assets to be distributed.

A word of caution: Naming a trust as beneficiary of retirement accounts needs to be done carefully, since the income tax rate for trusts is generally higher than it is for individuals. We can help you find the most tax-efficient approach to this situation, tailor your trust to your exact specifications, and make other improvements to help you accomplish your goals.

If you named a trust as the beneficiary of your IRA

Under previous retirement account rules, many people created trusts that were designed to act as “see-through” or “conduit” trusts, which made it possible for non-spouse beneficiaries to spread distributions and taxes over their lifetimes. Typically, the trust document included language specifically drafted to meet the requirements of rules that are now obsolete.

Currently, with retirement account distributions required to be taken within 10 years, those trust document instructions could cause major problems in terms of both taxes and the availability of funds to your beneficiaries. For example, a requirement that the trust withdraw and distribute to its beneficiary only the required minimum distributions from an IRA could be interpreted to mean the trustee must wait until the end of the 10 -year period to withdraw funds from the IRA, then make one large distribution at the end of 10 years. This could mean funds aren’t available to your beneficiary until 10 years after your death. Potentially even worse, that single distribution could result in the maximum amount of tax being paid, limiting the amount that goes to your beneficiary along with the timing issue.

It’s time to clear out your ‘toxic’ trusts

In most cases, trusts named as beneficiaries of retirement accounts need to be amended to resolve this conflict. In the meantime, it could be a good idea to remove trusts as beneficiaries immediately and add them back in again after the necessary revisions have been made to your trust documents.

Bring charity into the picture

Of course, the most tax-efficient thing to do with retirement assets has always been, and still is, to leave them to charity. Charities can receive 100% of your retirement assets free of income and estate tax, while non-spouse beneficiaries typically only receive a fraction, sometimes less than 50%, of the account’s total value, even when they handle taxes strategically.

In general, if you’re leaving money to charity, the first place those funds should come from is your retirement accounts. You don’t need to leave all your retirement assets to charity. You can leave a percentage or a specific dollar amount and still reap a tax benefit.

In addition, bringing charity into the fold opens up planning opportunities under the new rules. For example, one strategy that can benefit charitable organizations as well as individual beneficiaries—and save on taxes—is to leave your retirement accounts to a charitable remainder trust (CRT).

How a Charitable Remainder Trust Works

With a CRT, your retirement accounts transfer to the trust after your death without any tax obligation. So, 100% of the assets go into the trust. The only tax hit is on the annual distributions the trust makes to your beneficiaries, and those can be stretched out over a period that is usually much longer than 10 years. The result can be a strategy that is very similar to a Stretch IRA under the old rules. Then, at the end of the period, the property that remains in the trust goes to charity.

Taking a holistic approach

With the passage of the SECURE Act, we are working with many clients to evaluate the potential impact on their retirement accounts and find the most effective way to update their beneficiary designations, examining retirement accounts both in isolation and as part of the client’s overall financial plan and legacy goals. This requires close collaboration among our tax, planning and investment professionals, who examine the issue from multiple angles for optimal results.

If you have retirement accounts and want to ensure the best results for your beneficiaries, contact your Fiduciary Trust representative or call us today at (877) 384-1111.

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