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How the SECURE Act impacts IRAs left to a trust

Key takeaways

  • For many, the SECURE Act (signed into law on Dec. 20, 2019) changed the time-frame in which a beneficiary of an IRA must take withdrawals, which may impact the IRA owner’s estate planning efforts.
  • Leaving IRA assets to trust, rather than to individual beneficiaries, may be appealing because language in the trust can direct how and when the assets can be distributed to beneficiaries of the trust.
  • When working with an estate planning attorney, understand the differences between conduit and accumulation trusts and how each may affect your legacy goals.

Over the years, you listened to your financial planner and put money aside for retirement. You took advantage of tax-deferred growth1 by maximizing contributions into employer-sponsored retirement plans. You generated sizeable wealth within your qualified accounts during your long career. You thought about whether to leave assets outright or in trust for your beneficiaries and made sure the beneficiary designations on your qualified accounts aligned with your estate planning documents.

Then the SECURE Act 1.0 passed. Now what?

While the pre-SECURE Act 1.0 required minimum distribution (RMD) rules apply to retirement accounts of decedents who passed away before January 1, 2020, many of these RMD rules have changed for beneficiaries of individuals who are still alive.

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How the SECURE Act 1.0 impacts required minimum distributions

Although the SECURE Act 1.0 helped improve retirement security for many Americans, it took away the ability for many beneficiaries to take distributions from the IRA account they inherited throughout the course of their lifetimes. Pre-SECURE Act 1.0, beneficiaries could stretch required minimum distributions (RMDs) over their life expectancy, while allowing the remaining balance to potentially grow tax-deferred in an inherited IRA account. Younger beneficiaries typically benefited the most, as their longer life expectancies meant comparably lower RMDs each year. Now, most beneficiaries must withdraw the balance within a 10-year period,2 which accelerates the income tax due and may impact the original owner's legacy goal intentions.

A hypothetical example of retirement assets left outright to children

Let us say a parent died in December 2019 at age 72 with a $1 million IRA; her 3 children, ages 47, 43, and 40, were named as beneficiaries. In the first year after inheriting the IRA, each child, inheriting 1/3 of the account, will be required to withdraw as the RMD approximately $9,000, $8,200, and $7,650, respectively, based on their life expectancies.3 The stretch provisions result in: 1) smaller distributions, as compared to the parent's RMD of approximately $65,000 in the year of the parent's death, with the smallest calculated for the youngest child; 2) less of an annual tax impact; and 3) more of the account to continue to potentially grow income tax-deferred.

However, if the parent died in 2020, post-SECURE Act 1.0, all 3 children must withdraw the balance of the inherited IRA within a 10-year period4 regardless of their ages, resulting in accelerated income tax impacts and the loss of potential tax-deferred growth throughout their lifetimes. The children could generally pursue 3 options:

Option 1: Vary the amounts withdrawn each year (while satisfying annual RMD requirements), or withdraw the entire balance of $333,333.33 (each) in one year.

Option 2: Spread it evenly over 10 years by withdrawing $33,333.335 (assuming this satisfies annual RMD requirements), to try and manage the tax impact in any given year, in relation to their overall situation.

Option 3: Take various amounts each year based on their specific tax bracket in a given year, while still fulfilling annual RMD requirements.

Regardless of which option they choose, they must withdraw the entire amount by the 10th year following the parent's death. The cumulative tax impacts over the 10-year period could be much larger than the tax impacts of the life expectancy calculation, particularly when the beneficiary's other income is considered.

Leaving IRA assets outright versus in trust

Why would an IRA owner leave retirement assets to a trust rather than outright to a beneficiary? The IRA owner may be concerned that the beneficiary, upon inheriting the IRA, will deplete the assets immediately or not set aside funds to cover the taxes that might be due. As such, many people find the idea of leaving IRA assets to a trust, rather than to individual beneficiaries, appealing because they can include language in the trust directing when and how the assets can be distributed to the beneficiaries of the trust. The trust can also provide additional benefits, such as asset protection from creditors and centralized asset management.

See-through trust rules

Pre-SECURE Act 1.0, a trust needed to meet "see-through" requirements to ensure that as a beneficiary, the trust would qualify for life expectancy stretch provisions. There are 4 requirements to qualify as a see-through trust:

  1. The trust must be valid under state law.
  2. The trust must be irrevocable or become irrevocable upon the death of the account holder.
  3. All of the trust's underlying beneficiaries must be identifiable as being eligible to be designated beneficiaries themselves.
  4. A copy of the trust must be provided to the custodian by October 31 the following year after the account holder's death.

Post-SECURE Act 1.0, there was some uncertainty as to whether the "see-through" rules will apply because they were not specifically addressed in the SECURE Act legislation. The IRS, however, published proposed regulations in February 2022 which included "see-through" trust rules: These regulations acknowledge the "see-through" trust concept and allow the IRA assets to be withdrawn within a 10-year period.

Conduit vs. accumulation trusts

Over the years, conduit and accumulation trusts have been used to defer income tax payments from retirement accounts. However, this benefit can only take place if each trust qualifies as a see-through trust under the Internal Revenue Code. The primary difference between a conduit trust and an accumulation is whether the beneficiary or the trust would be responsible for the income taxes payable on the distribution.

Conduit trusts are designed to pay out all distributions, including RMDs, to the trust beneficiaries, with the beneficiaries paying the income taxes on the distributions. Pre-SECURE Act 1.0, if drafted properly, the trust could calculate the RMD based on the the life expectancy of each trust beneficiary and ensure the beneficiary's share is distributed to that beneficiary.

Essentially these distributions would continue for the beneficiary's lifetime. The way conduit trusts work—with assets passing out of the inherited IRA, into the trust, and then out to the beneficiary—has not changed post-SECURE Act. However, the impact of the SECURE Act is such that all of the inherited IRA assets would be distributed to the beneficiary within the 10-year period following the death of the original IRA owner.5 If the trust is a non-see-through trust, the timeframe is 5 years.

If we refer back to our prior hypothetical example, all 3 children will still have to receive their respective share of the inherited IRA. The children will have the trust benefits of asset protection (although not all US states provide such protection), and tax deferral for as long as the assets remain in the IRA. Any withdrawals taken from the IRA will be paid outright to each of them through the trust. This may be contrary to the IRA owner’s original intent of leaving the retirement assets to be held in a trust, with the expectation that small distributions will be made from the IRA, through the trust, and out to the beneficiary each year.

Historically, conduit trusts were used in 2 key ways: 1) to allow for beneficiaries to stretch out their payments over their lifetime while having the trustee maintain as much of the assets in trust for control; and 2) for asset protection. Now, conduit trusts no longer protect assets from creditors or the beneficiaries themselves outside of the 10-year period unless the beneficiary is an EDB, or eligible designated beneficiary.

Another potential pitfall: The specific language of the conduit trust may limit the trustee to make distributions based on the required minimum amount. Pre-SECURE Act 1.0, these required distributions were based on the life expectancy of the beneficiary. However, post-SECURE Act, depending on who the identifiable beneficiaries are, there may only be one required minimum distribution, which would be at the end of the 10-year period. This is only in cases where the original account owner dies before their own required beginning date.

Referring back to our example, if the IRA account owner had died prior to their required beginning date, then the trustee is limited to making distributions of the required minimum amount, and all of the children would receive their entire share of the IRA in the 10th year. This could result in a large tax bill in year 10, at higher marginal rates, particularly as the children's other earned income for that given year is considered. The language in the trust could limit the ability of a beneficiary to manage their tax liabilities within the 10-year time frame.

Accumulation trusts differ from conduit trusts in that they provide the trustee with discretion in determining whether to pay out or retain any distributions taken from the inherited IRA. This flexibility allows for assets to remain in trust protected from any outside creditors. It also alleviates the IRA owner's concern of having beneficiaries receive assets either too soon or in too large an amount.

It is important to understand what your estate plan establishes and if it is properly structured to reflect your wishes for your heirs. For example, if inherited IRA assets are left to an accumulation trust and all 3 children are named beneficiaries of the trust, the trustee may then reinvest these assets within the trust and determine when and how to pay out the assets to the named beneficiaries, based on the terms of the trust itself. If 2 of the 3 children are careful with their finances and one is not, the trustee may decide to distribute the assets to the 2 "responsible" children and retain the third child's share in trust with distributions being made at the sole discretion of the trustee.

However, accumulation trusts can likely trigger additional income taxation, particularly if the distributions from the IRA are retained in the trust. Trusts are taxed at compressed tax brackets and reach the top effective income tax rate sooner than individuals. For example, in 2023, a trust will reach the top effective income tax rate of 37% at income over $14,450, compared to an individual filer reaching the 37% bracket with over $578,125 of annual income or a married couple who files jointly reaching the 37% bracket with over $693,750 of annual income.

For 2024, the 37% tax starts over $15,200 for trusts, over $609,350 for individuals, and over $731,200 for married couples filing jointly.

Eligible designated beneficiaries and exceptions to the "new" general rules

Like all general rules, there are some exceptions. Under the SECURE Act 1.0, if you are considered an EDB, the 10-year payout does not apply, and the EDB can stretch payments out over the EDB's lifetime, with some further exceptions. EDBs include surviving spouses, minor children of the original IRA owner (until the age of majority, as defined by the IRS), disabled or chronically ill individuals, and beneficiaries who are no more than 10 years younger than the original IRA owner.

The stretch provision can also be used if the assets are held under a conduit trust for the surviving spouse's benefit, provided that the spouse is the only named beneficiary. Distributions can be stretched out over the spouse's lifetime, with RMDs beginning at the later of: 1) the year after the year of the owner's death; or 2) when the owner would have reached RMD age. Upon the surviving spouse's death, the remaining beneficiaries are subject to a 10-year payout period.

Keep in mind that the rules work differently if there are multiple trust beneficiaries. Consider consulting a financial professional regarding your specific situation.

Second marriages and inherited IRAs

What about second marriages or blended families? As a hypothetical example, let's consider a spouse who has adult children from a previous marriage and would like to leave his $1 million IRA to them while also providing for his second wife. He can leave his IRA to a conduit trust for the benefit of his spouse and name his children as remainder beneficiaries of the trust. The IRA would make distributions to the surviving spouse based on her life expectancy and, upon her death, the assets would pass to his children with the requirement that they be distributed from the IRA within 10 years following the spouse's death. Post-SECURE Act 1.0, the children could potentially inherit an asset that is worth less, as the taxation on the IRA is accelerated over 10 taxable years, compared to the pre-SECURE stretch provisions.

The importance of trust planning

Trust planning for retirement assets is still an effective tool even under the SECURE Act 1.0. If an IRA owner plans to leave retirement assets to trust, it is important to determine how to make this strategy work, based on their legacy wishes. For example, how important is control and asset protection compared to minimizing tax exposure? Are the beneficiaries able to handle large distributions? Answers to these questions can help influence the choice between a large outright distribution in a shorter period of time and tax deferral.

In summary, the SECURE Act 1.0 changed the rules that govern the application of how qualified assets must be distributed to the trust beneficiaries. The IRS did issue proposed regulation in February 2022 which, when finalized, will hopefully provide much-needed guidance on the see-through trust rules. With any new law or regulations, it's important to review your estate plan with a tax professional and an estate planning attorney to help ensure that your plan is aligned with your intentions.

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1. Assets will grow income tax free if contributions have been made to Roth accounts, but similar required minimum distribution rules will apply for beneficiaries. 2. See section in article on exceptions to new general rules. It is possible that distributions can be taken throughout the 10-year period, at the trustee’s discretion. 3. For purposes of this calculation, we assumed there was no growth in the retirement account and used the single life expectancy table. We also assumed, for simplicity sake, that the CARES Act, which allows people to skip RMDs in 2020, does not apply. 4. We assumed the children do not meet the definition of an Eligible Designated Beneficiary. 5. Unless the beneficiary is an Eligible Designated Beneficiary. It is possible that distributions can be taken throughout the 10-year period, at the trustee’s discretion.

Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.

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