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Should You Name a Trust or Individual as Beneficiary in a Post-SECURE Act World?

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Should You Name a Trust or Individual as Beneficiary in a Post-SECURE Act World?

On December 20, 2019, President Trump signed into law the Setting Every Community Up for Retirement Enhancement (SECURE) Act. This law puts into place sweeping changes to everything from providing more access to retirement plans, raising the Required Minimum Distribution (RMD) age to 72, and removing age restrictions for contributing to Traditional IRAs. Among all of the numerous changes, the one change that has many financial planners and the public alike scrambling to learn more about is the new rules that effectively remove certain “stretch” provisions from non-spouses who inherit retirement assets. 

In the past, when a person inherited retirement assets, they often had the opportunity to then distribute their inherited retirement assets on a schedule based on their own life expectancy. Thus, a younger beneficiary would be allowed to take smaller distributions than an older beneficiary, and either of them could always take more than the RMD. The SECURE Act now requires that all non-spousal beneficiaries have distributed all of their inherited retirement assets by the end of the 10th year following the original account owner’s passing. 

With all of these changes, there are many new considerations to be made. So, it is with great excitement that My Financial Coach is proud to bring you our first guest blog by one of our very own Subject Matter Experts. Jay Knighton is a Legal and Estate Planning Expert at the Texas law firm, Knighton & Stone

Below, Jay outlines a four-step decision tree for determining whether a client should name a trust or individual as a beneficiary to retirement accounts in light of the recent SECURE Act:

Step One:  Should your estate plan address the issues raised by the SECURE Act?  Key – look for language indicating that your estate plan contains a Retirement Benefits Trust, which is basically a trust designed to receive an IRA.  If your estate planning does not contain a Retirement Benefits Trust, then skip Step Two and Step Three and go to Step Four.  If your estate planning does contain a Retirement Benefits Trust, go to Step Two.

Step Two:  What do you anticipate as the income tax effect if the IRA transfers to a trust?  For most clients, the income tax effect is not as significant as they initially thought.  In an illustration in which a child inherits a $500,000 IRA in a trust vs. outright, and the child’s Adjusted Gross Income equals $100,000.  The potential income tax difference is approximately $6,500 each year for 10 years.  I will admit that $65,000 over 10 years is significant, but many clients share with us that they thought the difference would be significantly more.  Upon discovering that the potential income tax difference is not near as high as anticipated, many clients are fine with the IRA transferring to the trust.  After the analysis, if you are fine with the additional income tax, then go to Step Three.  If you do not want your children to pay the extra income tax, first consider Step Four with the outcome being most likely an amendment to the beneficiary designation.

Step Three:  Should you consider an outright transfer of the retirement plans vs. transfer in a trust?  This analysis simply boils down to answering a simple question, which is, “Do you want the benefits of a trust to attach to the tax-deferred retirement assets (IRA)?”  The benefits of a trust include:

(i)        Asset protection from a child’s creditors and potential divorce;

(ii)       Ensuring assets remain in the bloodlines after a child passes away;

(iii)      Excluding assets from estate taxes when children pass away; and,

(iv)      A trust permits a responsible 3rd party to serve as Trustee in order to ensure that the trust assets are properly invested and used by the beneficiary (not for all clients, but for many clients this benefit can be the #1 reason to create a trust [e.g. a 29-year-old child and the clients do not want the 29-year-old to serve as Trustee until age 35]). 

If you desire trust benefits to attach to your IRA, then you likely need to Amend your estate plan.  If you do not desire trust benefits to attach to your IRA, then you should Amend your beneficiary designation.  Either decision leads to Step Four.

Step Four:  What planning exists to mitigate the income taxes associated with an IRA transferring to a trust OR the additional income taxes due to a 10-year distribution requirement to an individual?  You should review this analysis with your wealth advisor.  Your options are somewhat limited; however, if you are counting on your beneficiaries receiving as much of the IRA as possible, you should consider:

(i)        Aggressive ROTH conversions because distributions from a ROTH to a trust or to the individual avoid the escalated income tax recognition;

(ii)       Obtain a life insurance policy that will create tax-free income liquidity to pay the additional income taxes;

(iii)      Consider a Charitable Remainder Trust designed for the beneficiary to receive a stream of income to mimic the lifetime minimum distribution rules under the old IRA laws. Keep in mind that Charitable Remainder Trust planning requires a certain amount of assets to transfer to a charity. Also, Charitable Remainder Trust planning requires significant legal work.   

Sincerely,

Jay Knighton

Board Certified Estate Planning and Probate – Texas Board of Legal Specialization

Master of Laws in Taxation

Knighton & Stone, PLLC

www.knightonstone.com

*The information provided in this blog does not, and is not intended to, constitute legal advice; instead, all information, content, and materials available on this site are for general informational purposes only. We recommend that readers meet with his or her own CPA, wealth manager, and/or estate planning attorney for a more thorough review of their own personal situation.

 

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