SECURE Act Impacts Decision to Name Trust as Beneficiary of Retirement Plan

Signed into law on December 20, 2019, and effective for those individuals who die after December 31, 2019, the SECURE Act made a number of changes with respect to qualified retirement plans and individual retirement accounts (IRAs). If a trust is to be designated as beneficiary of a retirement plan, the consequences of the SECURE Act must be considered. Under the SECURE Act, that choice will depend, more than it did under prior law, on the particular wishes of a plan participant and the facts and circumstances of an individual case. It is important for a participant who has designated a trust as beneficiary of a retirement plan or IRA to review the SECURE Act’s impact on that designation.

The SECURE Act increases the age at which a participant must commence receiving distributions from 70 1/2 to 72 years. The other major change is to eliminate the ability of most designated beneficiaries to stretch payments from inherited accounts over their life expectancies. The ability to stretch payments over a beneficiary’s life expectancy permitted the tax deferred accumulation of earnings for an extended period of time. Under the SECURE Act, most beneficiaries must receive distribution of all funds from inherited accounts within 10 years after the participant’s death. Exceptions are made for a surviving spouse and certain other beneficiaries. A surviving spouse continues to be permitted to roll over benefits into his or her own IRA or withdraw benefits over his or her life expectancy. 

Trust as Beneficiaries

The SECURE Act has significant impact upon plan participants who designate a trust to receive plan benefits at a participant’s death. A participant might name a trust as beneficiary of a retirement account with the objective of limiting the access or control that beneficiaries of the trust might have with respect to proceeds in the retirement account. This objective has been adversely effected by the SECURE Act.

If a plan participant dies without naming an individual as a designated beneficiary of a plan, the retirement account must be completely distributed within five years of the participant’s death. A trust does not qualify for any of the exceptions to the five-year rule unless it is a so-called “see-through” trust. A see-through trust is a trust of which all individuals who are counted as beneficiaries under IRS rules can be identified. Only individuals can be beneficiaries of a see-through trust. A trust which has a charitable beneficiary cannot be a see-through trust.

There are two types of trusts which qualify as see-through trusts. One type is a “conduit trust.” With a conduit trust, the trustee must distribute immediately all distributions received from a plan to a trust beneficiary. If there is more than one beneficiary eligible to receive distributions from the trust, the oldest is the “designated beneficiary.” The other type of see-through trust is an “accumulation trust.” The trustee of an accumulation trust is permitted to accumulate amounts received from a retirement plan. The oldest beneficiary eligible to receive distributions from the trust is the “designated beneficiary,” and provisions governing the administration of the accumulated trust must not permit distribution of any accumulated amounts to a beneficiary who is older than the designated beneficiary. This prohibition applies while the trust is in existence and upon its termination.

Under the SECURE Act, only a conduit trust for the sole benefit of a surviving spouse during his or her lifetime is permitted to receive distributions from a plan for a period measured by such spouse’s life expectancy. Any accumulation trust must receive distribution of all plan proceeds within 10 years of the participant’s death even if this participant’s surviving spouse is the designated beneficiary. This represents a change from pre-SECURE Act law which permitted an accumulation trust of which the surviving spouse was designated beneficiary to receive distributions over the spouse’s life expectancy.

Distributions and Possible Tax Consequences

The Act’s 10 year limit on distributions to non-spousal beneficiaries may initially make an accumulation trust for such beneficiaries seem more attractive, as a trustee retains control over any amount not distributed to a beneficiary. One problem with an accumulation trust, however, is the rate of income tax imposed upon plan proceeds retained by the trust and not distributed to a beneficiary. Distributions from a plan are taxed as ordinary income. For the year 2020, a trust reaches the maximum 37% tax bracket with taxable income in excess of $12,950.00. Retaining plan distributions in an accumulation trust may come at a cost.

The SECURE Act could have significant implications for your retirement and estate plan. Incorporating your retirement accounts in to your estate plan remains important, but may require a balancing act. If you have questions, please contact one of the members of Lewis Rice's Estate Planning Group to discuss how we can help ensure that your retirement assets pass in the most effective way possible.