SECURE Act Affects Retirement Plan Beneficiaries

The Setting Every Community Up for Retirement Enhancement Act of 2019 (“SECURE Act”), which went into effect this year, significantly changes retirement account rules including who can contribute and when you have to take withdrawals. While the SECURE Act has its share of perks, such as the removal of an age limit for IRA contributions and the increase of the required minimum distribution age to 72, a major drawback is that many beneficiaries are no longer allowed to take distributions over the course of their lives via a stretch provision, but must instead take all distributions within 10 years of the account owner’s death. Here’s an overview of SECURE Act’s possible impact on your beneficiaries and what you could do if you need to make a change to your estate plan in light of the new law.

Under SECURE Act, Most Beneficiaries Cannot Elect Stretch Status

Prior to the enactment of SECURE Act, a common option selected by a beneficiary was to stretch payments from an inherited IRA over the course of their lifetime based on their life expectancy so that they could achieve tax-deferred growth, better tax treatment on distributions, and even protection from creditors. SECURE Act basically put an end to this stretch option as it now requires that for all IRAs inherited after December 31, 2019, the beneficiary must take possession of inherited IRA funds within 10 years of the account owner’s death.

Fortunately, some of your beneficiaries might still be able to elect stretch status. This includes your surviving spouse, minor children, disabled and chronically ill beneficiaries, and those of your beneficiaries who are within 10 years of your age. This means that your surviving spouse can still take distributions over their lifetime or roll over assets into their own IRA. However, your children are another story. Once your minor child becomes an adult, they are subject to this new 10 year rule unless they are eligible for stretch status on other grounds such as being disabled.

SECURE Act’s Possible Impact On Naming Your Trust As An IRA Beneficiary

For decades, a popular estate planning strategy has been to make your trust the beneficiary of your retirement account. Your trust could be in existence before you die, or a testamentary trust could be established through your will. In either event, when your trust is your IRA beneficiary, distributions are made to your trust, and the terms of your trust dictate whether and to what extent distributions are made to your trust beneficiaries.

There are two types of trusts which are geared towards administering inherited retirement account payouts: conduit trusts and accumulation trusts. With a conduit trust (also known as a “see-through” trust), distributions made to your trust are supposed to be paid out to your trust beneficiaries each year rather than remain in the trust.

The conduit trust allows your trust beneficiary to pay tax at their income tax rate which is typically lower than the trust’s tax rate. It also enables your trust beneficiary to receive distributions over their lifetime via a stretch payout if they are an eligible beneficiary under SECURE Act. Otherwise, your trust might be forced under SECURE Act to receive taxable distributions over a much shorter period of time than the trust calls for, making this type of trust invalid or impractical.

With an accumulation trust (also known as a “discretionary trust”), your trustee has the power to hold the assets in the trust rather than make payment to your trust beneficiary. Notably, assets held in an accumulation trust are subject to trust tax rates which could be much higher than your trust beneficiaries’ income tax rates. In fact, trusts with more than $13,050.00 in taxable income are subject to 37% tax – the same tax rate of a single taxpayer making more than $523,600.00 or a married couple making more than $628,300 in 2021.

An accumulation trust is generally more viable if you have a Roth IRA since the trust generally does not pay any tax on Roth IRA distributions. This type of trust can also protect against a special needs beneficiary obtaining assets that might disqualify them for public benefits such as Medicaid.

Problem Children

A commonplace practice in estate planning is to put special provisions in trusts that empower your trustee to withhold distributions to those of your trust beneficiaries who are irresponsible, at risk of lawsuits, drug-addicted or otherwise dealing with substance abuse issues. These provisions can prevent one or more of your beneficiaries from spending all of their inheritance at the casino and can even protect them from their creditors. With a stretch provision, the trust not only allows the beneficiary to receive favorable tax treatment but also provides asset protection for as long as the assets remain in the retirement account.

Unfortunately, with the SECURE Act, a stretch provision may not be available for any of your problem children since there is no provision in the SECURE Act that allows your trust to opt for a stretch provision if your trust beneficiary is immature or irresponsible. This could mean that distributions which are required to be paid to the trust under the SECURE Act might need to be parked in another trust account in which distributions are made at your trustee’s discretion. Although this might not be ideal from a tax perspective, it could make sense for your trust to bear the tax consequences if the alternative is your problem child possessing and potentially wasting the money that you worked so hard to accumulate.

SECURE Act’s Impact On Disabled Children And Chronically Ill

Although the SECURE Act allows your disabled and chronically ill beneficiaries to elect stretch status, they would have to qualify as disabled or chronically ill as it is defined under federal law. According to federal law, a disabled beneficiary (defined in 26 U.S. Code § 72(m)(7)) is unable to engage in substantial gainful activity because of a medically determinable physical or mental impairment which is expected to result in their death or persist for some indefinite or long-term duration. Notably, your beneficiary might qualify as disabled under the terms of your trust but not under the government’s definition of disabled – even if your beneficiary is facing serious addictions or other challenges that reduce their ability to generate income.

According to federal law, a chronically ill beneficiary is someone who a licensed health practitioner determines is unable to perform at least two activities of daily living (e.g. eating, bathing, dressing, transferring, toileting) for at least three months because of a loss of their functional capacity; or someone who basically has to be extensively supervised to protect them from threats to their health and safety because of a cognitive impairment. This means that your beneficiary might not be ill enough in the government’s opinion to warrant a stretch provision.

If one of your children has special needs and would be eligible for stretch status, you could designate a special needs trust as your IRA beneficiary. In this case, your trustee could make distributions to cover your beneficiary’s support and care while still being able to stretch distributions from the IRA over your child’s lifetime. Even if your child does not meet the federal government’s definitions of disabled or chronically ill, a trust that is established for their benefit could still accomplish other goals that are as meaningful as mitigating tax consequences.

More SECURE Act Resources on ACTEC Foundation Podcasts

The American College of Trust and Estate Counsel (ACTEC) Foundation‘s podcast channel provides periodic discussions of many topics and issues concerning estates and trusts. Folks seeking more information about the SECURE Act may find the podcast channel’s 2019 and 2020 podcasts on the SECURE Act helpful.

Hawkins Elder Law Can Help You Modify Your Estate Or Retirement Plan

Now that the SECURE Act is law, you should have your estate or retirement plan reviewed to ensure that your assets are able to be distributed according to your wishes while providing adequate protection to your beneficiaries from a tax and an asset protection standpoint. For example, your conduit trust might have to be switched to an accumulation trust. It might make sense for you to convert to a Roth IRA or even change which assets that you have earmarked for your beneficiaries. An experienced estate planning attorney can help you decide.

For more than two decades, the attorneys at Hawkins Elder Law have helped countless clients with preparing estate plans that are tailored to their needs and which provide for the effective management and distribution of their assets. Founders Jennifer J. Hawkins and Jeff R. Hawkins are Board Certified Indiana Trust and Estate Lawyers, certified by the Trust and Estate Specialty Board. Reach out to Hawkins Elder Law today by calling (812) 268-8777 or by contacting us online.

About the Authors

Jeff R. Hawkins and Jennifer J. Hawkins co-author the Hawkins Elder Law blog with Thomas E. Hynes, a lawyer who is admitted in Pennsylvania, New Jersey and Florida with a background in estate planning and elder law.

Jeff and Jennifer Hawkins are Trust & Estate Specialty Board Certified Indiana Trust & Estate Lawyers. They are also active members of the Indiana State Bar Association and National Academy of Elder Law Attorneys. Both lawyers are admitted to practice law in Indiana, and Jeff Hawkins is admitted to practice law in Illinois.

Jeff is a Fellow of the American College of Trust and Estate Counsel and the Indiana Bar Foundation. He is also a member of the Illinois State Bar Association. He served as the 2014-15 President of the Indiana State Bar Association.

Hawkins Elder Law is one of the few elder law firms that Martindale-Hubbell^TM has rated AV Preeminent, with both of the firm’s lawyers (Jeff Hawkins and Jennifer Hawkins) also rated AV Preeminent.

More Information

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