Their Impact on Trust Planning for Retirement Plans
As a planning tool, trusts can provide many benefits for beneficiaries under directions set up by a conscientious grantor, typically an upper-generati on family member. These benefits may include asset protection from future creditors, professional investment management, and even some assurances that a family financial legacy won’t disappear due to unchecked spending habits of less-disciplined benefi ciaries. The fact that trusts can provide these benefits, potentially for generations, has made them particularly effective in dealing with a range of assets, from investment portfolios to family business interests to retirement assets, such as employer-provided plans or individual retirement account (IRAs). In addition, before the SECURE Act was passed in 2019, if a trust was named as an IRA or retirement plan beneficiary, that trust structure was also a way to maintain tax benefits (in the form of “stretching” out the income tax liability) as if individual beneficiaries were named.
The SECURE Act however, enacted a 10-year distribution requirement, which seriously curtailed the ability of IRA or other retirement plan benefits to be stretched out overall, limiti ng that capability to only certain classes of individuals referred to as “eligible designated beneficiaries.” Those who meet this distinction generally include the surviving spouse and certain forms of dependent beneficiaries.
For that same treatment to be afforded within a trust post-SECURE Act, the trust must not only be a so-called “seethrough” trust, which looks to benefit only named, identifiable individuals, but must also be a “conduit” trust – one that is required to annually pass all trust income through to beneficiaries. (That is of course assuming the beneficiaries themselves would be considered “eligible designated beneficiaries.”) If these requirements are not all met, the plan assets must be distributed out of the plan or IRA within 10 years of the plan participant’s death. If the beneficiary is a trust, that means the trust will need to receive those distributions within that timeframe, incurring the corresponding income tax burden at the higher trust marginal rates; note that these higher rates are imposed at a much lower income level than they are with individuals.
Of course, if the plan income is paid out to trust beneficiaries during the same year it is distributed out of the IRA or plan to the trust, the trust itself will not pay the tax, but the beneficiaries will. If that income on the other hand is maintained within the trust – perhaps to continue providing those benefits in what is known as an “accumulation” trust – those taxes will apply at the trust level.
Prior to the SECURE Act, trusts that were IRA or plan beneficiaries were often designed to be either “conduit” or “accumulation” trusts based on the intention of the grantor, knowing that distributions from these accounts would ulti mately be taxable to the trust or beneficiaries when taken out. Of course, for certain beneficiaries, such as surviving spouses, not much has changed, even with the enactment of the SECURE Act. However, for those “accumulation trusts” designed for beneficiaries who are not “eligible designated beneficiaries,” the required distribution timeframe out of the plan or IRA has now been accelerated. It may be time to look at whether a “conduit” or other alternative planning approach may be worth considering.
The SECURE Act and SECURE Act 2.0 brought these and many other changes that can impact estate and retirement planning. For further details regarding these changes, please contact your Baird Financial Advisor.
Baird Trust does not provide individualized tax or legal advice. Please consult your att orney or accountant for individualized legal and/or tax advice including how these changes in legislation apply to your personal situation.
