Planning for Common Scenarios Under the SECURE Act

SECURE Act — 5 Part Special

1. Updating Existing Estate Plans Under the SECURE – posted April 21, 2020
2. Planning for Common Scenarios Under the SECURE Act – (this podcast)
3. Designing and Drafting Trusts in Light of the SECURE Act – posted May 5, 2020
4. Disabled or Chronically Ill Beneficiaries Under the SECURE Act – posted May 12, 2020
5. Charitable Planning and the SECURE Act – posted May 19, 2020

“Confronting the Challenges of Tax Reform,” that’s the subject of today’s ACTEC Trust and Estate Talk.

Transcript/Show Notes

Welcome to part two of a five-part series offering professionals information about the SECURE Act, which was signed into law in December 2019. SECURE stands for Setting Every Community Up for Retirement Enhancement.

“Planning for Common Scenarios Under the SECURE Act,” that’s the subject of today’s ACTEC Trust and Estate Talk.

This is Travis Hayes, ACTEC Fellow from Naples, Florida. Today we will be discussing the recently enacted SECURE Act’s impact on common estate planning issues such as naming adult children and surviving spouses as beneficiaries. To give us more information on this topic, you will be hearing today from ACTEC Fellows Natalie Choate, of Boston, Massachusetts and Steve Trytten of Pasadena, California. Welcome, Natalie and Steve.

SECURE Act – Spouse as Primary Beneficiary

I think we will begin with: whom do you designate on the death beneficiary designation? For married couples, under the law prior to the SECURE Act, we almost always designated the spouse individually as the primary beneficiary. For so many reasons, that made sense when we had a full life expectancy method available to the children or whomever of those beneficiaries might follow the spouse. Now that that has been cut back to a 10-year rule for most beneficiaries – other than a few exceptions – as we take another look at that, I think the spouse individually is still going to make sense in most cases, but it is a little closer call than it used to be. So, if you were not going to designate the spouse individually, what might you do? Well, you could do a conduit trust, which normally you would make that a marital trust that qualifies for the estate tax marital deduction. If you wanted some structure, for example, you were worried that perhaps the spouse is not going to handle the money, or you have a blended family and you want to try to protect some money for the kids. But, just remember that with a conduit clause, if that spouse lives to or beyond life expectancy, most of that plan will be drained out during the spouse’s lifetime. So, if the trust is also intended to preserve a portion for the children, that conduit approach may not work. If you do any trust for your spouse other than a conduit, you are not going to qualify for the life expectancy of that spouse, and you will have the 10-year rule apply. So just a short list of options, but I think that sums up our spousal options. So, maybe Natalie, you’d like to offer some comments on how we designate children.

I will, Steve, and thank you. I am just going to review what you said on spouses to make sure I understand it. It used to be that there were three doors open for benefiting your spouse with retirement benefits. You could leave the benefits outright to the spouse, who could roll them over to his or her own IRA and keep deferral going that way for quite a while. That door is still perfectly open. You could leave retirement benefits to a conduit trust for your spouse, under which you would qualify for a life expectancy payout based on the surviving spouse’s life expectancy, and the IRA would be gradually depleted through payments of those required minimum distributions over the spouse’s life expectancy. So, you would get a life expectancy payout; but if the spouse lived to their full life expectancy, the whole account would be depleted through payments to the spouse. There would be nothing left for the next beneficiary. That door is still open. You can still do that. The third door, which is not as open as it used to be, was the accumulation trust, where you would leave your IRA to a trust for the spouse; she would get the income of that trust but not all IRA distributions. Some IRA distributions would be held in the trust for the spouse for the rest of his or her life and eventually paid out to, presumably, the donor’s children. That door is the one that is pretty much partially closed now. I mean, you can still do it, but you do not get a life expectancy payout for it anymore. All the distributions are paid out of the IRA to the trust within ten years after the original spouse’s death, which means they are going to be taxed at trust rates. And that will be the price of “saving” some of the benefits for the remainder beneficiaries, i.e., the children presumably of, typically, of the first marriage, and that is the purpose of SECURE. It is what we are going to soon find also applies when we are leaving retirement benefits to children. The purpose of SECURE is fundraising, to raise up to $15.7 billion dollars out of our clients’ retirement plans, and the way they do that is by accelerating the distribution of retirement benefits.

SECURE Act – Children as Beneficiaries

As we have seen with the spouse, in a certain kind of trust, the distributions are now accelerated and taxed sooner. Same we will find with children. Let’s take a client who has just one healthy, competent adult child and wants to leave his million-dollar IRA to that daughter, say. Under pre-SECURE rules, the IRA could be left to the daughter, and she could take it out gradually over her life expectancy. If she was 50 years old, that life expectancy would be 30, 40 years, a very gradual payout of the inherited IRA, many decades of continued income tax deferral after the parent’s death.

Now, that same parent dies and leaves that million-dollar IRA to the same daughter; she has to cash it out within ten years after the parent’s death. She can cash it all out in the first year. She can wait until the last year. She can take a little bit every year, but one way or another, the deferral is limited to 10 years after the death of the original owner.

Now, with some of those clients, we may find when we are discussing with them – under their prior estate plan – maybe that client left his IRA to a trust for that adult daughter because he figured, what the heck. The trust will take minimum distributions over her life expectancy and pay those out to her, and this will make sure the money’s still there when she gets old and does not lose it to a spouse that I do not like or some other catastrophe that might happen. Some of those parents are now saying, “Am I really going to bother to set up a trust that is just going to last for ten years?” Just leave it outright to the child, get the ten-year payout and we are done, or maybe even look around; rearrange your estate plan a little bit. Maybe, in some cases, there will be another beneficiary in the family. The parent will say, “Well, I will leave some other asset to my daughter. She is in a very high tax bracket. She is in her peak earning years. I will leave her some other asset, and maybe I will leave the IRA to my sister, who is my same age and she would get a life expectancy payout as a, say, close-in-age beneficiary.” That kind of thinking.

The tougher case is for the parent whose adult child, though legally competent and not disabled or anything like that, is a spendthrift or has some other problems where their parent is going to say, “Leaving it outright to this child is not an option. This child is married to somebody I hate, and he is going to steal all the money, or they have a gambling problem, a drug problem, or they just spend money. I cannot leave the IRA outright to this child.” That parent will leave the IRA to a trust for the child to protect the child and protect the money, but the price is going to be that the money has to be paid from the IRA into that trust within ten years after the original owner’s death. Since it cannot be just paid right out to this particular child, it has got to be kept in the trust, and that means it is going to be taxed at trust tax rates.

The trust goes into the highest tax bracket of 37 percent at just $13,000 of taxable income. So, the taxes are going to be paid sooner and they are going to be at a higher rate; and that person’s problems are easy compared to the parent who is trying to leave money for the benefit of minor children. Supposedly, SECURE gives a life expectancy payout for a donor who leaves his IRA to his own minor children, but it is a fake life expectancy payout. It only continues until the minor attains majority. So that will be a subject for much more study, to figure out – is it worth giving this money to the minors at too young of an age, that we don’t want to give it to them at that young age, just to get the mini life expectancy payout that lasts till they are 18 or 21, at which time it flips to a 10-year payout. Or, do we want to give up on any kind of life expectancy payout and go with a longer trust that will be subject to the 10-year rule. Steve, what do you think about that?

I think that is a great recap of the options with children, and I think you make a great point. You get the same deferral rule, whether it is outright or in an accumulation trust. So, it would be easy to say, “Well you have got nothing to lose, you could do either one.” But your point is so important, about the tax rates are likely those compressed tax rates in a trust. You are probably going to pay a lot more income tax. So it is going to be more of a dilemma than clients are used to before – of choosing between what they would have done if it was not for these rules and whether they are going to adjust and do something different to try to save tax.

Well put.

Tune in next week for our third SECURE Act topic: Drafting Trusts in Light of the SECURE Act.

Visit actec.org/secure-act to find additional resources.

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