Planning for the Young Under SECURE

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

Transcript/Show Notes

This is Travis Hayes, ACTEC Fellow from Naples, Florida.

As clients and practitioners await finalization of the proposed Treasury regulations applying provisions of the SECURE Act, they need to appreciate some of the nuances regarding beneficiaries that have not reached majority, such as minors and young adults.

ACTEC Fellow Svetlana Bekman of Chicago, Illinois, joins us today to explain what we should keep in mind about the SECURE Act as we design estate plans for clients. Welcome Svetlana.

Introduction of Relevant Estate Terms

Svetlana Bekman:  Thanks for this opportunity, Travis. Alrighty, so in this podcast, I’m going to assume that the listener has familiarity with certain definitions, like Eligible Designated Beneficiary — or EDB- Designated Beneficiary — or DB — conduit trust, and accumulation trust. And a few more words about terminology. When I say owner, I mean an IRA owner or a participant in an employer sponsored qualified retirement plan. Retirement assets will mean either an IRA or a qualified retirement plan. And, finally, inherited IRA is an account that will hold the retirement assets after the owner’s death. And with this preamble, let’s dive in.

The SECURE Act provides that a child of the deceased owner who is a minor is an EDB. And then the Regs tell us further that a minor is a child who has not reached the age of 21. Only a child of the owner, not a grandchild, a stepchild or any other person who has not yet reached the age of 21 would fit within this category of EDB. If the child is adopted or was conceived using reproductive technology, we think that they will likely qualify as child of the owner if treated as such and are applicable under state law.

While the child is under 21, RMDs (Required Minimum Distribution) are calculated based on the child’s life expectancy using the single life table, subtracting one each year. Then when the child reaches age 21, the 10-year rule will kick in. And this means that the RMDs based on the life expectancy of the child- again using the single life expectancy table- will continue until the child attains age 31. And the child then must withdraw all assets from the inherited IRA by 12/31 of the year when the child attains age 31; and I will call this the life expectancy plus 10-year rule for purposes of this podcast.

So let me now walk you through several ways that the owner can leave retirement assets to their child. So, the owner can certainly name the child as an outright beneficiary. But if the child is under 18, doing so is not advised because it would generally require a court proceeding to appoint a conservator or a guardian of the estate for the child because, of course, until reaching the age of majority under state law, the child has no legal capacity to contract and take title to the inherited IRA.

Instead, the owner should consider naming a custodian under the Uniform Transfers to Minors Act, UTMA, as beneficiary. For example, a beneficiary designation might read something like this:

“If Amos Jones has not reached the age of majority under Illinois law at the time of my death, I name Amy Jones as custodian for Amos Jones under the Uniform Transfers to Minors Act of Illinois as beneficiary of my IRA.”

This approach eliminates the need for a court proceeding. As in EDB, Amos can stretch the inherited IRA until age 31 as I described earlier. However, just because he can wait until age 31 to withdraw the account does not mean that he will. In the words of one commentator, the child could throw one heck of a party at age 21 or perhaps earlier, depending on state law– because legally Amos, in our case, will have full access to the inherited IRA at age 21 when the custodianship under the UTMA terminates. Nevertheless, I think that if the retirement assets are modest in value, naming a custodian under UTMA as a beneficiary may be optimal.

Naming a Conduit Trust as Beneficiary of Retirement Account

Now, for larger retirement asset accounts, the owner and the planner really should consider trust. If the owner names a conduit trust as beneficiary of the retirement assets, for income tax purposes, the trust will work precisely the same as if the child were named as beneficiary or if the UTMA custodian for the child were named as beneficiary.

This means that all RMDs payable to the trust will be based on the life expectancy of the child and all distributions from the inherited IRA to the trust will need to be passed out to the child because such is the structure of a conduit trust. The trust could contain a facility of payment clause that would enable the trustee to distribute RMDs to the child’s custodian or parent, or to use the funds for the child’s benefit. And then, once the child reaches age 21, annual distributions will continue to be calculated based on the child’s life expectancy for the next 10 years. The entire inherited IRA will need to be distributed to the conduit trust no later than the end of the year the child attains 31. And remember, this is a conduit trust, so therefore that final distribution will have to be distributed outright to the child, at age 31.

So you can immediately see the downside of a conduit trust. All distributions have to be passed out to the child. And as the child gets older, the RMDs get larger. And at age 31, the RMD, by definition, equals the balance of the account. And if the child lacks maturity to handle substantial assets, a conduit trust structure may not be appropriate.

On the other hand, at least until age 31, the trustee is in charge of investing the inherited IRA, can optimize the distribution period by using the child’s life expectancy, and, most importantly, prevents the child from withdrawing the entire inherited IRA prior to age 31.

Naming an Accumulation Trust as Beneficiary of Retirement Account

Now, let’s look at the accumulation trust. I think it’s likely the best planning option for a significant retirement account — significant in terms of the amount. The special rule in the Proposed Treasury Regulations, which, you know, we’re still waiting to be finalized, provides that the minor child of the owner will still be an EDB even if there are trust beneficiaries who are not EDBs. Because of this special rule, the trustee can use the life expectancy method to calculate RMDs until the child attains age 31. However, if the child is not the oldest beneficiary of this trust, RMDs will be based on the life expectancy of the oldest beneficiary and, therefore, will be larger than if the child were the sole beneficiary.

When the child attains age 31, the inherited IRA will have to be distributed in full to the accumulation trust. But note, just because the inherited IRA terminated, the accumulation trust continues, and the clear benefit of this structure is that the trustee is not required to pass out any of the RMDs or any other distributions it receives from the inherited IRA. And, as I just mentioned, when the inherited IRA terminates, the trust remains intact. The trust provides professional investment management and creditor protection for the funds remaining in the trust and it will preserve after-tax assets in the control of the trustee, who will be empowered to make distributions to or for the benefit of the child at the trustee’s discretion. And indeed, this trust can remain intact for the lifetime of the child.

Of course, to the extent that the inherited IRA distributions are trapped in the trust, they are also subject to income tax at the trust level. And speaking of taxes, so far my discussion focused on RMDs, and they represent the minimum amount that must be distributed to the trust from the inherited IRA. The drafters should provide guidance to the trustee as to whether to withdraw more than the RMD when needed to provide for the beneficiary or whether to use non-IRA assets if they’re available. And, in addition, it may not be tax-efficient to defer a large distribution from the inherited IRA to the final year when the child attains age 31. The drafters should think about that and provide guidance as to the timing of distributions to the trustee and, in any event, exonerate the trustee from liability when the decision is made in good faith and is reasonable in light of the circumstances at the time the decision is made.

An Age 31 Trust – Leaving Retirement Assets to a Beneficiary Who Is Not an EDB

So far, I have been speaking about how to leave retirement assets to an owner’s child. Young beneficiaries who do not have that relationship to the owner are not EDBs and, therefore, do not qualify for what I call the life expectancy plus 10-years rule. However, the Treasury regulations have created for us a new tool and we should consider this tool when the owner wants to benefit an individual other than their child. The tool is the age 31 trust.

To qualify as an age 31 trust, the terms of the trust must provide that all retirement assets payable to the trust must be distributed outright to the young beneficiary no later than the end of the calendar year in which the young beneficiary turns age 31. The age 31 trust is essentially an accumulation trust, and it can have multiple beneficiaries. All trust beneficiaries — other than the young beneficiary who will receive the assets at age 31 — are disregarded for purposes of RMBs. But the 10-year rule still applies because our young beneficiary is not any EDB. Now, let me illustrate the age 31 trust with an example based on what you will find in the Proposed Treasury Regulations.

Example of an Age 31 Trust

Sharon, who is age 75, wants to leave her IRA to her grandson James, who is 15. She establishes a trust for James’s benefit with distributions to him for health, education, and support and then the trust further provides that it will terminate and distribute info to James when he attains age 31. If James dies prior to the scheduled termination, then the amounts remaining in the trust will be paid to Sharon’s favorite charity. When determining how to calculate RMBs to be distributed to James’s trust, the charity can be disregarded. This means that the trust will be treated as a designated beneficiary – DB — and will be subject to the 10-year rule. RMBs will be calculated using James’s life expectancy for nine years after Sharon’s death and then in year 10, the inherited IRA will distribute in full to the trust. But remember, the trust itself does not terminate until James attains age 31.

You can see that what we have here is an accumulation trust until James attains age 31 and, as such, the trust will enjoy all of the benefits of a trust structure: professional investment management, creditor protection, and trustee control of the trust assets until James attains age 31. In addition, the trust will be eligible for the 10-year income tax deferral- it will be subject to the 10-year rule. And I should note that the age 31 trust is a tool, it’s an option that is also available to the owner for their own child. It doesn’t have to be used for an individual who has a different relationship to the owner than the child. It can also be used for the child.

And with that, I hope that this overview provided the planners and their clients actionable insights to use in planning for minor beneficiaries.

Travis Hayes:  Thank you, Svetlana, for discussing the operation and application of the SECURE Act when there are minor beneficiaries of retirement accounts.

 

Additional Resources

• Resources for Wealth Management Professionals – SECURE Act
• Top 10 Recommendations for Planning Retirement Benefits under the SECURE Act (Nov 2022)
• The SECURE Act and Retirement Account Planning Opportunities (Feb 2022)

Resources to Share with Clients

• Transferring Assets to a Minor Child
• Should I Serve as a Trustee?

This podcast was produced by The American College of Trust and Estate Counsel, ACTEC. Listeners, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal or tax advice from their own counsel. The material in this podcast is for information purposes only and is not intended to and should not be treated as legal advice or tax advice. The views expressed are those of speakers as of the date noted and not necessarily those of ACTEC or any speaker’s employer or firm. The information, opinions, and recommendations presented in this Podcast are for general information only and any reliance on the information provided in this Podcast is done at your own risk. The entire contents and design of this Podcast, are the property of ACTEC, or used by ACTEC with permission, and are protected under U.S. and international copyright and trademark laws. Except as otherwise provided herein, users of this Podcast may save and use information contained in the Podcast only for personal or other non-commercial, educational purposes. No other use, including, without limitation, reproduction, retransmission or editing, of this Podcast may be made without the prior written permission of The American College of Trust and Estate Counsel. If you have ideas for a future ACTEC Trust & Estate Talk topic, please contact us at ACTECpodcast@ACTEC.org. © 2018 – 2024 The American College of Trust and Estate Counsel. All rights reserved.