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Estate Planning with Retirement Plan Assets Under the SECURE Act: One Size No Longer Fits All Estate Planning with Retirement Plan Assets Under the SECURE Act: One Size No Longer Fits All


The SECURE Act made significant changes to how retirement plan assets are treated after the death of the account owner. But perhaps the biggest impact from the perspective of estate planning attorneys is the way the SECURE Act must now shape planning discussions with clients. Incorporating retirement assets into an estate plan will require the estate planner to have thoughtful conversations with clients in order to understand their priorities with respect to those particular assets—and then draft a plan that works within the new legal framework.

How does the SECURE Act change prior law governing withdrawals from inherited retirement plan assets?

The SECURE Act made a substantial change to the rules regarding a beneficiary’s withdrawals from an inherited retirement plan after the death of the original account owner. Under prior rules, an individual beneficiary (referred to as a “designated beneficiary”) could withdraw retirement plan assets over the course of his or her own life expectancy. Certain kinds of trusts could also qualify as a “designated beneficiary” to allow for withdrawals based on the life expectancy of the oldest trust beneficiary.

The SECURE Act changed the life expectancy withdrawal provisions for all but a select few types of beneficiaries (now called “eligible designated beneficiaries”). Eligible designated beneficiaries, who can still withdraw retirement account assets over their life expectancy, include a surviving spouse, minor children (but only until they reach the age of majority), a disabled or chronically ill person, or any individual who is less than ten years younger than the original account owner. A trust for the sole benefit of an eligible designated beneficiary can still qualify for life expectancy withdrawals as well. However, adult children are not eligible designated beneficiaries and neither are minor grandchildren—so neither group is eligible for life expectancy withdrawals. In addition, without further clarification from the IRS, it is no longer clear that a trust that benefits multiple minor children could qualify as an eligible designated beneficiary, either.

Now, any person who inherits a retirement plan and is not an eligible designated beneficiary must withdraw the entire amount of the account within ten years from the date of death of the account owner, instead of spread over the course of his or her own life expectancy. A beneficiary can withdraw money from the retirement account gradually over the years or even in a single lump sum, so long as the entire amount is withdrawn within the ten-year period.

The effect of that change can be substantial on tax-deferred retirement plan accounts from an income tax perspective, as a result of condensing the payout of the account into a shorter term of years. The ten-year rule still holds true even if a trust is named as the beneficiary of the retirement plan (unless the trust is for the sole benefit of an eligible designated beneficiary).  This may have even more significant income tax implications if the retirement account withdrawals are held in the trust instead of distributed outright to the beneficiaries right away when they are taken out of the account. That’s because trusts are taxed at the highest 37% income tax rates beginning at just $12,950 in income (as compared to $510,301 in income for single filers or $612,351 for married filing jointly).

How do these changes impact estate plans?

Before the SECURE Act was enacted, clients usually did not have to choose between their heirs being able to defer income taxes on retirement plan withdrawals and maintaining control over the timing and amount of distributions from the plan to their beneficiaries. An aging parent could leave a million dollar IRA to a trust for the benefit of an adult child, and the child could get the benefit of deferring income taxes on IRA withdrawals over the child’s life expectancy, while the parent could rest assured that the terms of the trust would put some guardrails around the child’s access to the funds. The SECURE Act now takes that option off the table in many cases. To move forward, estate planners should talk with their clients to determine the clients’ highest priorities with their retirement dollars.

Discussing estate planning with retirement plan assets with clients: What are the client’s priorities for their retirement plan dollars?

Of course, estate planning has always involved talking with clients to understand their priorities and then designing a plan that accomplishes those goals. But before the SECURE Act, clients could often choose between leaving their retirement plan accounts to their intended beneficiaries directly or sending those accounts to a properly-drafted trust for the benefit of those heirs—and there was no difference from an income tax perspective between either choice.

Now, there is no longer a “one-size-fits-all” approach to estate planning with retirement plan assets. Instead, estate planners should consider walking through the following questions with clients:
  1. How much money is anticipated to be in tax-deferred retirement plans upon the client’s death?

    If only a small percentage of the client’s net worth is held in tax-deferred retirement accounts, then it may be the client is not overly concerned about the income tax effects of their desired plan on those assets. On the other hand, leaving small-dollar retirement accounts directly to the client’s intended beneficiaries instead of routing them through a trust would likely streamline administration substantially. Finally, depending on the client’s income tax situation, a client may wish to consider converting tax-deferred retirement plan accounts to Roth accounts during the client’s lifetime. No matter which option the client chooses, to begin estate planning with retirement plan accounts (especially tax-deferred accounts), it is important to know what dollar values are at issue. Once those amounts are known, next ask:
  2. What is the client’s priority:

    a. Maximizing potential income tax savings for their heirs; or

    b. Maximizing control over the timing and amounts of distributions to their heirs?
Many clients may be most concerned about maximizing potential income tax savings for the intended recipients of their tax-deferred retirement plan accounts. There are a number of options to achieve that result, including:
  • Directing the retirement plan accounts to pass directly to individual beneficiaries. This option has the advantage of combining the best possible income tax result for individual beneficiaries (regardless of whether the client’s heirs are “eligible designated beneficiaries” or “designated beneficiaries”) with the simplest administration after the client’s death. However, the recipient of the inherited retirement account will have complete discretion over when and how much to withdraw from the account. Those considerations may make this option appealing to clients who have financially responsible adult beneficiaries, such as a surviving spouse or adult children.
  • Directing the retirement plan accounts to separate trusts for the benefit of each individual beneficiary that require all plan assets to be distributed out of the trust to the beneficiary upon withdrawal from the retirement account (known as “conduit” trusts). This option can still provide optimal income tax results, but may be more difficult to administer after the client’s death with the retirement account held in a continuing trust. It also requires careful identification of the correct trust on the beneficiary designation form for the account. Clients who want to maintain some level of control over the timing and amount of distributions to their heirs but are comfortable with the fact that any withdrawals from the retirement plan would need to be immediately distributed out of the trust to (or for the benefit of) their intended beneficiaries should consider this option. As an example, separate conduit trusts could be a good choice for parents of minor children because they would allow each child to receive life expectancy withdrawals until they reach the age of majority, followed by a ten-year payout period thereafter. This provides the best possible income tax deferral option for a minor child while still allowing some control over the amount and timing of distributions.
  • Creating a charitable remainder trust. Clients who are charitably inclined should particularly consider this option. A charitable remainder trust could benefit an individual beneficiary with income during his or her lifetime, while leaving the remainder upon the beneficiary’s death to a favorite charity, all with the favorable tax treatment attendant with charitable trusts.
However, some clients may be more concerned about maximizing control over who receives their tax-deferred retirement plan dollars (and when) than they are about minimizing income taxes that will be paid on those sums. In that case, the client should consider the following option:
  • Creating a trust that allows the trustee to accumulate in trust amounts withdrawn from the retirement account instead of distributing them immediately to the beneficiaries (an “accumulation” trust). A properly-drafted accumulation trust could offer the highest degree of asset protection and discretion for a trustee to decide whether to make distributions from a retirement plan account to a trust beneficiary experiencing personal or financial issues. For example, clients with a child struggling with addiction might wish to consider this option. This type of trust could also allow retirement plan dollars to benefit a surviving spouse during his or her lifetime while ensuring that whatever amounts remain in the account upon the surviving spouse’s death would benefit the original account owner’s children—for instance, in a second marriage where both spouses have their own adult children. The drawback, however, is that any amounts held in the trust would be taxed at trust income tax rates.
All of these options have pros and cons clients should understand in order to make an informed decision about their desired estate plans. There are no easy answers to the questions created by the SECURE Act when it comes to incorporating retirement plan accounts into a client’s estate plan, but by asking the right questions, estate planners can help guide clients to the best result for them.

For additional information about the SECURE Act and retirement planning, please contact Elizabeth Timme or another member of our Trusts, Estates and Private Wealth Group.

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