trust planning

Proposed Legislation Could Bring Big Changes to Trust Planning for Retirement Accounts

Before we dive into big changes possibly coming down the pike in trust planning for retirement accounts, it’s disclaimer time. This post is not specific legal advice. Although I am a Florida licensed attorney, the intent of this communication is to inform generally as to the possible estate planning impacts of legislation currently being considered in both chambers of Congress. Also, as this is a synopsis of proposed legislation, no action is necessary at this time.

After years of advising clients on a combination of estate planning and financial planning needs, Congress is considering legislation that would demand alterations to many of those plans. All that work down the drain. Or better said by Robert Frost, “Nothing gold can stay.”

The SECURE Act passed the House on May 23, 2019 by a vote of 417-3. The Senate is considering its own version of the bill (thankfully with some substantive differences) but that version has yet to come to a vote. Should the Senate pass a different version, the final bill would have to get through Conference Committee and then a final vote from both chambers before heading to the President’s desk for signing. So while it’s not a done deal, it’s heading that way quickly.

Although there are a number of provisions in the House version of the bill, the one we’ll focus on deals with the elimination of the “Stretch IRA” strategy when an IRA account is left to a non-spousal beneficiary. Specifically, we’ll focus on when an IRA account is left to a Trust after the original account owner’s passing.

As a quick refresher, the Stretch IRA strategy describes a non-spousal beneficiary inheriting an IRA account from an owner that was in required minimum distribution (RMD) phase. That non-spousal beneficiary is then allowed to “stretch” out the RMDs over his/her lifetime only withdrawing the required minimum distribution each year.

Let’s hypothetically say that Ward and June Cleaver (both age 80) have two children, Wally (55) and Ted (50). Ward has an IRA account worth $1,000,000. Let’s also assume that although Ward and June love their children equally, Wally is far more financially sophisticated and responsible than Ted. With those considerations in mind, Ward and June make the following plan:

1)      50% of Ward’s IRA will pass to Wally (if both Ward and June have passed away); and

2)      50% of Ward’s IRA will pass to a Trust for Ted’s benefit, where the only distributions available to Ted are the annual RMDs from the IRA account, with Wally as the Trustee.

June passes and Ward passes soon after her. According to the beneficiary plan left on Ward’s IRA account, 50% of the IRA is distributed to an Inherited IRA for Wally’s benefit. The remaining 50% is distributed to an Inherited IRA for Ted’s benefit owned by the Cleaver Family Trust with Ward as Trustee.

Under current law, if Ward and June hired a competent attorney, Ted would be able to receive the RMDs from his half of Ward’s IRA for the rest of his life or as long as the Trust owned Inherited IRA had funds to distribute to him. The RMDs would be calculated using Ted’s life expectancy and distributions would be taxed at Ward’s personal income tax rate.

I’ve simplified things greatly here to illustrate the basics (I didn’t discuss the difference between a “conduit trust” and an “accumulation trust” and also assumed the Cleaver Family Trust qualifies as a “see-through” trust - if you’re having a bout of insomnia feel free to research those terms, they’re instant sleep aid material). In short, this isn’t an uncommon strategy for trust planning.

Here’s the rub. The House bill would limit this strategy’s distribution timeline to just 10 years instead of over Ted’s lifetime. Therefore, if the House version of the SECURE Act becomes law and the Cleaver Family Trust was not amended, Ted could receive 9 years of “normal” RMD payments from the Trust. But in year 10, the remaining balance of the Inherited IRA account would have to be fully distributed to Ted and included in Ted’s taxable income for that year. For someone who already isn’t financially savvy, which is why the Trust was established to begin with, such a windfall could be disastrous.

The hits don’t end there, though. Keep in mind that 50% of Ward’s IRA was distributed to an Inherited IRA for Wally. Although Wally is good with money and responsible, the 10 year distribution rule applies to him too.

For many retirees, their IRA accounts represent the bulk of their assets. Creating well-planned and reasonable distribution strategies that protect beneficiaries who might have issues with money makes a lot of sense. So why are we getting the SECURE Act with the 10 year distribution provision? In a word, taxes.

Current tax policies are leaving the government coffers shorter and shorter every year and reducing the distribution schedule of IRA accounts of taxpayers after they’ve passed is the place Congress is looking to pick up additional revenue. And who will complain? The original account owner is deceased, as is the spouse of the original account owner, and the 10 year distribution provision would only apply to non-spousal beneficiaries. Mom and dad saved the money, so they had skin in the game. But the Beaver? This is found money to him, so taxes be darned, a 10 year distribution schedule doesn’t make a difference to him.

Thankfully, all is not lost. Using our previous hypothetical, the proposed legislation simply says the assets must leave the Inherited IRA owned by Ted’s Trust, that doesn’t necessarily mean they have to be distributed to Ted as an individual, they just have to be distributed from the Inherited IRA account. So savvy estate planners will guide clients towards language that would allow for intra-Trust distributions and transfers in the hopes of combating the mandatory 10 year distribution rule.

To wrap things up, again, this is an analysis of proposed legislation, so estate planning-minded investors and advisors would be well served to make sure they’re Washington watchers for updates through the remainder of this Congressional term.