SECURE Act: Naming a trust as beneficiary of a retirement account

The SECURE Act, passed in December of 2019, has fundamentally changed the rules on when beneficiaries have to take assets from retirement accounts, including the elimination of the so called “stretch” option, with some exceptions.

With $29 trillion dollars in retirement accounts, the change means several of us will need to change our estate plans.

The stretch option allowed beneficiaries of retirement accounts to take annual required minimum distributions (RMDs) based on their life expectancies.

In other words, the younger the beneficiary, the longer timeframe they had to distribute the account and spread out the tax due.

Now the SECURE Act requires most beneficiaries must completely empty the retirement account by the end of the 10th year after the year of death (10-year rule), accelerating the tax due. This creates several issues for beneficiaries, including potential concerns around listing a trust as beneficiary of retirement accounts.

Before the SECURE Act, many trusts were created with “conduit” features that allowed income from trust owned assets to “look through” the trust and distribute income to the beneficiaries. This would allow distributions to be spread over the beneficiary’s life and pay the tax due on their personal return vs. the higher trust tax rates. Another common benefit of these trusts was the ability to protect these inherited assets from future creditors or divorce, for example.

Under new law, most beneficiaries are forced to distribute retirement accounts under the 10-year rule.

This means that the assets inherited through a conduit trust will go to the beneficiary in a relatively short period of time and would then become their personal asset. If your goal when creating your trust was to provide lifetime income for your beneficiaries and/or creditor protection for your beneficiaries, the conduit provision may no longer be the best feature to have on your trust.

But you do have options.

One solution may be to amend your trust to replace the conduit features with accumulation features. This change would allow the trustee to retain, or accumulate, the distributions from retirement accounts inside of the trust.

The SECURE Act would still force distributions over the 10-year period, but the trustee could have the discretion to leave those dollars inside the trust, which would allow the trustee to more fully realize the lifetime asset protection features of the trust.

This change does come with a potential major drawback.

If these distributions are kept inside the trust, they would be taxed at trust tax rates, which hit the 37% level at only $12,950 of income on the federal level.

So, if you are leaving a large retirement account balance, it would still need to be distributed after 10 years and beneficiaries could face a very large tax bill.

However, under the accumulation structure, the trustee has the discretion to decide what to do. If the trustee believes the high tax rate of the trust is more detrimental than losing asset protection, they could allow the distributions to flow through to the beneficiary at the individual tax rates. But, if there is a more compelling reason — such as asset protection in a divorce— to keep the distributions in the trust, the trustee can retain the distribution in the trust.

Another major concern with the 10-year rule is that there is technically no required minimum distribution until the last year, year 10. Some trust language limits the trustee to only distribute the RMD amounts. Depending on the exact language of your trust, this could mean the trustee is forced to cash out the entire account balance in year 10 only. This would not allow for any flexibility on when to take distributions and would lump all the tax liability into one year, likely pushing the beneficiary into a much higher tax bracket.

But you can avoid this by updating the language in your trust to allow trustees to have discretion over distribution timing.

It’s a good idea to review and update your trust documents every several years. Now with the law changes in the SECURE Act, it’s timely to review these documents with your attorney to make sure these changes are accounted for in your estate planning documents. Typically, this can be done through an amendment of your existing documents and would not require your trust to be re-drafted from scratch.

Please reach out to a Wipfli Financial advisor if you have questions on how these laws coordinate with your personal financial plan.

CONTACT AN ADVISOR

SECURE Act: Naming a trust as beneficiary of a retirement account

Jake Harmsen
Jake Harmsen

Senior Financial Advisor

Jake has built his career in accounting and personal finance. As a senior financial advisor with Wipfli Financial, as well as a certified public accountant (CPA)*, Jake has the experience to look at all aspects of his clients’ financial lives.

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SECURE Act: Naming a trust as beneficiary of a retirement account

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