Planning for a marital trust to hold retirement account assets has always required carefully drafted distribution and administrative trust provisions, especially when planning for spouses married for a second time. The SECURE Act, signed into law by President Trump on December 20, 2019, makes dramatic changes to the distribution rules for retirement accounts upon the death of the account owner. The general rule now is that retirement accounts must be distributed to designated beneficiaries within ten years of the death of the account owner. Surviving spouses are one of five exceptions to the general rule (such beneficiaries are called “Eligible Designated Beneficiaries” in the statute) and still can qualify for a lifetime, or stretch, payout.
The SECURE Act layers on additional hoops for estate planners to jump through in order to ensure that a marital trust is eligible for the life-expectancy payout. This article will describe the existing rules for marital trusts holding retirement plan assets as well as the new rules under the SECURE Act relevant to marital trust planning. The article will also review options for distribution of any remaining retirement assets held in the marital trust upon the death of the surviving spouse as the applicable rules for distributions to successor beneficiaries were also upended by the new legislation.
The surviving spouse of the account owner can rollover an inherited IRA just as under prior law. Under the new law, the required minimum distributions (“RMDs”) would need to begin in the year the deceased spouse would have attained age 72. While a spousal rollover does minimize the income tax liability of the survivor, it does not protect the assets from creditors beyond the spouse’s lifetime or necessarily preserve the remaining balance of the account for children. Especially in second marriage situations, many attorneys advise their clients to transfer retirement account assets to a QTIP Marital Trust where the surviving spouse is the only beneficiary during his or her lifetime but the remainder is earmarked for heirs. In order for the QTIP trust to utilize the lifetime payout option, it must be drafted as a “Conduit Trust.” A “Conduit Trust” is a trust with a provision governing retirement account distributions that requires the trustee to distribute to the individual beneficiary each distribution the trustee receives from the retirement plan. The IRS Regulations provide that the beneficiary of a Conduit Trust is the sole designated beneficiary of the trust as well as the retirement account and therefore that individual’s life expectancy may be used to determine the RMD. The IRS has ruled that the surviving spouse must receive not only all of the income of a QTIP marital trust but also all of the income of any retirement account payable to the trust. It is important that marital trusts state this explicitly to avoid IRS scrutiny. Many attorneys provide in their marital trust agreements that the trustee shall distribute to the surviving spouse the greater of the income of the retirement plan or the RMD each year and this language will continue to satisfy the IRS rules for a QTIP Conduit Trust.
A Conduit Trust is the only marital trust that will qualify the surviving spouse as an EDB and allow for a lifetime payout of the IRA to the surviving spouse. The IRS does not consider the beneficiary of an income only marital trust an EDB and thus the trustee of such a trust would have to withdraw the account within ten years of the account owner’s death.
The conference report of the SECURE Act notes explicitly, nonetheless, that upon the death of the surviving spouse the ten-year payout rule will kick in for the successor beneficiaries unless such beneficiaries are otherwise EDBs. Depending on the ages of the successor beneficiaries and size of the retirement account, this new rule could cause large distributions to the successor beneficiaries. Not only could this be problematic if beneficiaries with little or no financial acumen are given a large lump sum distribution, but also such distributions would likely trigger a large tax liability. Depending on the ages of the successor beneficiaries, one solution is to provide for an Accumulation Trust. An Accumulation Trust gives the trustee the discretion to either retain or pass out distributions to fulfill the goals of the trustor and minimize taxes. For example, it may make sense to withdraw the account over years seven, eight, nine and ten or to make distributions over the entire ten-year period to take advantage of a beneficiary’s lower tax bracket. Under this tax strategy, the trustee would make distributions of as much of the income and principal of the account each year up to the top of the beneficiary’s tax bracket but not so much as the beneficiary is then pushed into a higher tax bracket. This will require coordination between the beneficiary, trustee and accountant.
If the successor beneficiary were a minor, then he or she too would be an EDB for so long as the beneficiary is under age 18, or 21, depending on state law. It’s unclear at this point, whether the IRS will recognize separate shares for minor children such that each minor child would separately qualify as an EDB and as each child reached majority, the ten-year payout would be triggered solely for his or her share of the retirement account. The IRS Regulations prior to the SECURE Act had looked at the oldest trust beneficiary to set the measuring age but it is hoped that the IRS will effectuate the policy of protecting minor’s assets and permit each child to be separately treated as an EDB.
The SECURE Act creates a new hierarchy of winners and losers for inherited IRAs. Attorneys will need to understand the new law and work with their clients to create flexible trust provisions that ensure the best result possible.