IRA Trust Beneficiaries after the Secure Act by Rimon Partner Brent Nelson
Insight Brent Nelson · January 10, 2020
There are two schools of thought on naming at trust as a beneficiary of an IRA: (1) NEVER DO IT, and (2) do it if it meets your goals. The First camp lives and dies on the belief that naming a trust accelerates distributions from the IRA–thus more tax sooner, and that is usually bad. The Second camp lives and dies on playing with somewhat complex rules that prevent that bad result if the rules are strictly followed. I am in the Second camp. The Secure Act, however, changes the landscape for the Second camp somewhat.
The Secure Act says that for IRA owners dying after January 1, 2020, any designated beneficiary that is not (1) the owner’s spouse, (2) the owner’s child who is under age 18, (3) a disabled individual, (4) a chronically ill individual, or (5) any other person who is not more than 10 years younger than the owner, must take out the balance of the account within 10 years of the owner’s date of death (the “Ten-Year Rule”). The individuals in the list of five are referred to as “Eligible Designated Beneficiaries.” The Ten-year Rule only applies to “Designated Beneficiaries,” and does not apply to a beneficiary that is an Eligible Designated Beneficiary or that is not a Designated Beneficiary at all.
A Designated Beneficiary is only an individual names as beneficiary of an IRA –an estate, charity, or trust (usually) is not an individual and therefore not a Designated Beneficiary. The rules, as modified by the Secure Act, state that if there is an Eligible Designated Beneficiary of the IRA, then the beneficiary has to withdraw the account balance over the longer of the beneficiary’s or the owner’s life expectancy. Surviving spouses also get special rules that allow them to step into the shoes of the owner, withdraw the IRA balance of their life expectancy, or roll the IRA into the spouse’s owner IRA. If the IRA names a mere Designated Beneficiary, who is not an Eligible Designated Beneficiary, then the Ten-Year Rule applies. If the IRA did not name a Designated Beneficiary (e.g. it named an estate or charity as a beneficiary of any portion of the IRA) then one or two other rules applies: either (1) the beneficiary has to take the entire account balance out within five years of the owner’s death, if the owner was under age 72 when the owner died (the “Five-Year Rule”), or (2) the beneficiary has to take the entire account balance out over the owner’s remaining life expectancy, if the owner died after age 72 (the “Payout Rule”). Thus, the classification of the beneficiary and the owner’s age at death are all relevant in determining how quickly the beneficiary must withdraw (and thus be taxed on), the funds in the IRA when the owner dies.
If a trust is names as the IRA beneficiary–and it is valid and meets certain disclosure rules–the trust beneficiaries, rather than the trust itself, are used to determine the classification of the beneficiary of the IRA (a so called “Look-Through Trust” because the trust’s existence is ignored for this purpose).
If the trust states that one or its beneficiaries must receive all withdrawals from the IRA directly out of the trust and the trust cannot accumulate any of the withdrawals, then only that beneficiary is treated as a beneficiary of the IRA–and thus that beneficiary’s classification matters (a so called “Conduit Trust”). If the trust beneficiary of a Conduit Trust is a non-individual, then the IRA is treated as having no Designated Beneficiary. If the trust beneficiary is an individual, then the respective rules of Eligible Designated Beneficiaries or Designated Beneficiaries apply, depending on the individual’s classification. Historically many trusts named as beneficiaries of IRAs provided that the trustee must withdraw the required minimum distribution each year and pay those amounts, plus any other withdrawals from the IRA, to the beneficiary each year.
If the trust can accumulate withdrawals from the IRA, then any contingent or remainder beneficiary is included among the class of beneficiaries to determine if the Look-Through Trust has a Designated Beneficiary (a so called “Accumulation Trust”). The hitch is that most trusts name estates or charities as beneficiaries in some direct or indirect manner in the case of an Accumulation Trust, and because those are non-individuals, an Accumulation Trust is typically subjected to either the Five-Year Rule or the Payout Rule, absent careful drafting around the issue.
Determining how to incorporate trusts as beneficiaries of IRAs under the Secure Act, is a complicated conundrum. The trust can still be treated as a Look-Through Trust. The Conduit Trust and Accumulation Trust rules above apply. But, the calculus of which approach is better is much harder. If the owner dies before age 72, then clearly making the trust qualify for the Ten-Year Rule is better than the Five-Year Rule, because the IRA can hold and grow investments tax-free for longer. In that case, a Conduit Trust with an individual beneficiary would usually be preferred. If the owner dies after age 72, then the Payout Rule is potentially better than the Ten-Year Rule, because the life expectancy of a 72 year old, under the IRS tables in Regulation 1.401(a)(9)-9, is 17.1 years. The tables turn against this conclusion when an owner reaches age 82, at which point the owner’s life expectancy is 9.9 years. Thus, an Accumulation Trust with an indirect non-individual beneficiary might be preferable for an owner between age 72 and 82, because it would not be subject to the Ten-Year Rule but would be subject to the Payout Rule.
To clarify, because the Payout Rule is better than the Ten-Year Rule in some cases, naming individuals directly as IRA beneficiaries is in fact not the most tax efficient option if the owner is under age 82. It is the simple option–just not the optimal one.
A trust provision that can flip between the options depending on the age of the IRA owner at the owner’s death would be ideal. Whether the IRS would accept that kind of trust provision is unclear. However, current IRS positions strongly imply that if such a provision is not in the trust before the owner’s death, it cannot be retroactively added when the owner dies. So, owners should consider adding a provision that can flip between options, just in case.
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Brent Nelson assists U.S. and international individuals, families and financial institutions in tax, estate planning and family business matters. In addition, he frequently speaks and writes on estate and tax developments. Brent develops estate plans in a wide variety of circumstances, from basic estate plans to complex plans for high net worth individuals and families. He also assists them with related business succession and charitable goals. For high net worth clients, he uses sophisticated tax planning techniques involving irrevocable trusts, life insurance, private foundations and family limited partnerships. Other lawyers often engage Brent to help their clients in complex planning. Read more.
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