by Kevin Rigg: Director of Financial Life Planning & Lead Advisor
Earlier this year I highlighted provisions of the recently passed SECURE Act that impact IRA account holders (https://bit.ly/2ZcTzzZ). Perhaps the most significant change discussed in that post is most non-spouse beneficiaries are now required to distribute funds from inherited retirement accounts within 10 years (eliminating the ability to “stretch” those distributions over their life expectancy).
The Act created a new type of retirement account beneficiary (“Eligible Designated Beneficiary”), the only type still eligible for the IRA “stretch” treatment. A Non-Eligible Designated Beneficiary is now subject to the aforementioned 10 year distribution rule and a Non-Designated Beneficiary remains subject to a 5 year distribution rule.
This change is significant for retirement account owners and creates the need to revisit beneficiary designations and consider strategies to mitigate the tax impact to those beneficiaries. Several ideas for doing so are explored below.
Trust Beneficiaries – Designating a trust as a beneficiary has traditionally accomplished the dual purposes of control and direction of the retirement accounts while stretching distributions over the trust beneficiary’s life expectancy. However, a recent memo from the law firm Montgomery Purdue Blankenship & Austin in Seattle pointed out that “it may no longer be appropriate to name a trust as a retirement account beneficiary, or it may be advisable to revise the trust provisions”. That same memo offered the following alternative approaches for consideration:
Name an individual as beneficiary, especially for smaller accounts and if there are no concerns about creditor claims or the beneficiary’s ability to manage assets.
Ensure the trust is setup as an “accumulation” trust, which allows the trust to retain the assets after they are distributed from the retirement account (in contrast to a “conduit” trust that requires distribution to trust beneficiaries).
Continue to use a trust for spouses since they are considered “eligible” beneficiaries and can stretch distributions over their life expectancy.
Charitable Remainder Trust (CRT) – Naming a charity as a retirement account beneficiary can be advantageous since a charity does not have to pay tax on future distributions. More complex charitable planning may allow someone to accomplish their charitable goals and provide heirs the ability to stretch distributions over their life. In a recent memo, Lauren Pitman at Lifetime Legal in Olympia addresses this type of planning and states “for those who wish to ensure a beneficiary receives an income stream while satisfying their charitable goals, a CRT may be the solution”. This is accomplished by following these steps:
Name a CRT as a beneficiary of the retirement account.
Distribute income annually from the CRT to individual trust beneficiaries over their life.
Pay the balance of the CRT to a charity after the death of the trust beneficiaries.
Planning Strategies – These are some additional strategies to consider for proactively dealing with the recent tax law changes:
Increase the number of beneficiaries on a retirement account to effectively spread out the income subject to the 10 year rule and reduce the overall tax impact.
Strategically weigh individual beneficiaries amongst the various retirement accounts (i.e. IRA and Roth IRA) based on each beneficiary’s personal tax situation.
Utilize Roth conversions to pay the tax now (assumes the tax rate on conversion is lower than tax rate likely to be paid by the beneficiary).
At SoundView we have always believed it is important to review beneficiary designations on a regular basis to ensure they are consistent with the estate plan and stated asset transfer goals. As noted above, the SECURE Act has introduced significant changes to the post death rules for retirement account owners. Reviewing beneficiary designations on these accounts is more important than ever and will be an area of focus in the financial life planning we do for clients through the remainder of the year.