How Does the SECURE Act Affect Your Estate Plan?

The SECURE Act went into effect at the beginning of this year and has significantly impacted both retirement planning and estate planning. We urge all of our clients with trust as part of their estate plan to check in with us to ensure that their trust document does not need to be updated after this change in the law. We also urge all of our clients, no matter what service we have provided, to reach out to a financial planner to make sure their retirement plan does not need to be similarly updated.

The main way the SECURE Act may impact your trust is with the termination of “stretch” distributions of inherited retirement accounts. Previously, clients planned on passing on significant qualified retirement accounts because they could grow tax-free with compound interest. Their beneficiaries would inherit that money, set up their own inherited retirement account, and were given the option of withdrawing all of the money in the account immediately, within 5 years, or stretching it over their lifetimes based on their projected life expectancy. A prudent beneficiary would plan to stretch the distributions out over their lifetime in order to minimize the impact upon his or her income tax because such distributions are countable as income and would increase the beneficiaries’ tax rate.

Now, however, beneficiaries cannot stretch out their inherited retirement account distributions over their lifetime – it must be done within 10 years. This likely will drastically increase the beneficiaries’ tax rate and the overall amount of income tax paid on the inherited money. Depending upon the size of the retirement account, some beneficiaries could be looking at the loss of tens of thousands – if not hundreds of thousands – of dollars in taxes.

Many clients are now working with their financial advisors to rely upon other vehicles of passing on their wealth instead of relying upon qualified retirement plans – such as insurance or non-qualified retirement plans. Other clients are re-considering what beneficiary designations on those accounts should be based on their beneficiaries’ income tax rates.

On the estate planning side, outdated language in your trust should be removed which references stretch IRAs, lifetime distributions, and the old age for required minimum distributions (formerly 70.5, now 72).

Another way the SECURE Act may impact your trust is potentially switching from a conduit trust for a qualified retirement plan proceeds to an accumulation trust. Previously, when IRA distributions could be stretched out over a minor beneficiary’s lifetime, a conduit trust was a popular choice to name as the beneficiary of that account. That way the trustee would receive payouts on behalf of a beneficiary like a minor child or young adult and immediately use it for the benefit of that beneficiary, while still using the beneficiary’s income tax rate.  The money stayed out of the beneficiary’s hands directly, and there was preferred tax treatment.

Now, however, since an account must be drained within 10 years, the distributions for minor children or other beneficiaries are much higher since it isn’t stretched over their lifetime. Spending $4,000 a year on a minor child is no problem, but spending $40,000 per year is more problematic – it becomes wasteful. Now, instead of forcing the Trustee to pay an excessive amount of money out for the benefit of the child, it may be more prudent to retain it in the Trust for later in the child’s life. This incurs a higher tax rate, but ultimately ensures that the child will be looked after for their lifetime and not just ten years.

Reach out to your estate planning attorney today for a review of your trust document to remove old language made ineffective by the SECURE Act and discuss if a conduit trust or accumulation trust is more appropriate for retirement plan proceeds, based on your situation.

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