Beneficiary Designations and the SECURE: Prior Designations

Clients spend lots of time, money, and energy planning their estates. Estate Planning attorneys help them by counseling these clients and preparing various documents to meet the goals of the client, such as a Will or Trust.

An increasing part of American wealth is governed by beneficiary designations. According to Statista, Americans had over $32 trillion in retirement assets alone. That’s trillion with a “t.”

As examined in prior posts, under the SECURE Act, a beneficiary typically must take all distributions by the end of the year which includes the 10th anniversary of the Participant’s death. The prior posts also outlined how EDBs can use their own individual life expectancy. However, a minor child of the Participant only qualifies as an EDB while a minor and then falls under the general 10-year rule of the SECURE Act.

A common strategy prior to the SECURE Act was to use a conduit trust for the child of the Participant/client in order to stretch the distributions over the child’s life expectancy while dribbling out distributions to the beneficiary over the beneficiary’s lifetime. The trustee would only take out the RMDs and make those available to the beneficiary, as required to achieve conduit trust status. This would provide the child payments throughout the child’s life and would be perfect for a child whose financial maturity was in doubt.

Unfortunately, if the Participant dies after December 31, 2019, the SECURE Act would apply. Under the Act, even if the conduit trust for the beneficiary child is an EDB (because it is a conduit trust for a minor child of the Participant and named directly as beneficiary), the trustee must pull out all of the assets of the retirement plan 10 years after the child reaches age of majority. So, the beneficiary designation which was designed to spread distributions over the life of the child now would give the child access to the entire retirement plan 10 years after the child reaches age of majority.

What could be done to solve this problem? You could modify the trust so that it’s no longer a conduit trust. The trust share for the child would be under the 10-year rule (because it would not be an EDB) but it could keep the retirement plan assets in the trust and only pay them out to the beneficiary in the discretion of the trustee. Of course, to the extent the trust retains the retirement plan proceeds in the trust, the income taxation on the distributions would be taxed to the trust and would not be carried out to the beneficiary on a K-1. This could cause the distributions to be taxed at a higher marginal rate. (Trusts are taxed at the highest marginal rate on amounts above $13,500 of taxable income, whereas a single individual reaches the top bracket on amounts over $523,600 and a married individual filing a joint return reaches the top bracket on amounts over $628,300.) But at least the trustee could weigh these tax and non-tax considerations.

Beneficiary designations can be deceptively simple. Just beware the rest of the iceberg. Be sure your beneficiary designations will have the desired outcome post-SECURE Act.

Beneficiary Designations and the SECURE: Eligible Designated Beneficiaries

Clients spend lots of time, money, and energy planning their estates. Estate Planning attorneys help them by counseling these clients and preparing various documents to meet the goals of the client, such as a Will or Trust.

An increasing part of American wealth is governed by beneficiary designations. According to Statista, Americans had over $32 trillion in retirement assets alone. That’s trillion with a “t.”

This post examines “eligible designated beneficiaries” who are exceptions to the standard 10-yr rule of the SECURE Act. The next post will examine how beneficiary designations done prior to the Act might not work as intended after the Act.

As examined in the prior posts, under the SECURE Act a beneficiary typically must take all distributions by the end of the year which includes the 10th anniversary of the Participant’s death. However, not all beneficiaries are covered by this requirement of a more rapid distribution. Some beneficiaries are “eligible designated beneficiaries,” otherwise known as “EDBs.” An EDB could take distributions based on their own life expectancy, just like prior to the SECURE Act.

EDBs under the Act are:

  1. The surviving spouse of the Participant. (The surviving spouse could also do a spousal rollover and thereby consider the assets as in their own retirement plan, like under prior law.)
  2. The child of the Participant under the age of majority. However, once the child reaches age of majority, they fall under the general 10-year rule of the SECURE Act. It’s important to note that a minor child of someone else, such as a grandchild, niece, or nephew, is not an EDB.
  3. Someone less than 10 years younger than the Participant,
  4. Someone who is “disabled” (within the meaning of Section 72(m)(7) of the IRC), or
  5. Someone who is “chronically ill” (within the meaning of Section 7702B(c)(2) of the IRC)

Note that the disabled or chronically ill beneficiary must meet the definitions as of the death of the Participant in order to be an EDB.

A trust for the benefit of an EDB also qualifies as an EDB. However, with the exception of a disabled or chronically ill beneficiary, the trust share of the EDB must be named directly and that trust must be a “conduit” trust.

After the SECURE Act, planning to stretch retirement plan distributions is much more difficult. One way to do it is to have retirement assets go to an EDB, such as a disabled beneficiary, and other assets go to other beneficiaries.

However, one group of EDBs is rather illusory. The minor child of the Participant is an EDB, however, they lose their EDB status upon adulthood and fall under the 10-year rule. Therefore, if the child of the Participant is the beneficiary, they’d have all the assets typically at age 28. Often, clients would prefer not to have their retirement assets go outright to their children at an age when they may not have suitable discretion. Unfortunately, leaving the assets in a trust for the child’s benefit won’t help because, by its nature, a conduit trust would give the beneficiary control or access to the funds upon distribution from the retirement plan. Again, that means the Participant’s child would have control of the assets at age 28.

Beneficiary designations can be deceptively simple. Just beware the rest of the iceberg.

Beneficiary Designations and the SECURE Act Basics

Clients spend lots of time, money, and energy planning their estates. Estate Planning attorneys help them by counseling these clients and preparing various documents to meet the goals of the client, such as a Will or Trust.

An increasing part of American wealth is governed by beneficiary designations. According to Statista, Americans had over $32 trillion in retirement assets alone. That’s trillion with a “t.”

The SECURE Act passed in December 2019. First, the SECURE Act changes the age for lifetime Required Minimum Distributions (“RMDs”) from age 70½ to age 72. This change is generally good for savers since it delays the date at which distributions must be taken from retirement assets. This is helpful in two ways. First, it allows the assets to grow tax-deferred. Second, for that additional 18 months from 70½ to 72, the account holder won’t have the tax liability of the distributions.

Once the owner of the IRA (the “Participant”) reaches that age (their “Required Beginning Date”), generally they must take out distributions under the Uniform Table, which represents the joint life expectancy of someone their age and a fictitious spouse 10 years younger (whether or not they are married). If they have a real spouse who is more than 10 years younger, they’d use a joint life expectancy using the real spouse’s age.

The biggest change of the SECURE Act concerns the rules for distributions by those whom the Participant names as the beneficiary to receive the assets after the Participant’s death. Prior to the Act, non-spousal beneficiaries could take distributions based on their own single-life expectancy. So, the younger the beneficiary, the longer the permitted distribution period.

Often, attorneys would advise clients to name the youngest beneficiary possible to get the maximum stretch. For example, if the client/Participant named their newborn grandchild, the distributions could be stretched over more than 82 years!

Generally, it’s better to defer retirement plan distributions as long as possible. Deferring distributions allows the assets to grow tax-deferred (or tax-free in the case of a “Roth” account).

Under the SECURE Act, non-spousal beneficiaries must withdraw all the assets by the end of the year which includes the 10th anniversary of the Participant’s death. Under prior law, the beneficiary could take distributions each year over the beneficiary’s life expectancy. So, this is a much more rapid distribution of the retirement benefits.

Let’s look at an example:

John dies leaving $1 million to his daughter, Beth, who is 25 years old. John dies in February 2021. The SECURE Act applies to the distributions to Beth since John died later than December 31, 2019. The 10th anniversary of John’s death occurs in February 2031. Beth doesn’t need to take any distributions for the first 10 years, but she needs to take everything by December 31, 2031.

As a practical matter, often the beneficiary won’t want to wait until the last possible date to take all the assets. If they waited until the final year, all of the income from the distributions would be taxed in that one year. Often, it’s better to spread the income over several years in order to obtain a lower marginal tax rate.

Beneficiary designations can be deceptively simple. Just beware of the rest of the iceberg. The next blogs in this series on beneficiary designations will examine the exceptions to the SECURE Act’s 10-year rule and how beneficiary designations which might have been ideal before the SECURE Act might now have unintended consequences.

Beneficiary Designations

Clients spend lots of time, money, and energy planning their estates. Attorneys help them by counseling these clients and preparing various documents to meet the goals of the client, such as a Will or Trust.

All too often a client forgets to mention and the attorney forgets to ask about assets that pass via beneficiary designations. This could be disastrous for all concerned.

An increasing part of American wealth is governed by beneficiary designations. According to Statista, Americans had over $32 trillion in retirement assets alone. That’s trillion with a “t.”

Experienced Estate Planning attorneys know there can be a great deal involved in deciding to whom the retirement assets should go and how. But let’s look at a simple example of a retirement plan designation screw up.

John was married to Betty. John had a small IRA on which John had named his mother as the beneficiary many, many years ago. John didn’t think much about the IRA. It only had $30,000 and he hadn’t touched it in many years. He also had a retirement plan at work which had several hundred thousand dollars. The retirement plan at work named Betty as the beneficiary.

John and Betty consulted an Estate Planning attorney who helped them with a plan leaving everything to the survivor of them with appropriate distributions to their children after the death of the survivor of them. The small IRA would still go to John’s mother.

When John retired, he was considering what to do with his retirement plan. He was frustrated by the investment options available under his work retirement plan. He knew an IRA had much more flexible investment options. So, John did a rollover of the retirement plan into his IRA.

John had forgotten that he had named his mother as the beneficiary of his IRA. The assets which had been in his retirement plan, which comprised the bulk of his assets, now would go to his mother instead of his wife at his death. Worse yet, while Betty had assets of her own from her employment, John’s children likely would lose out on the bulk of the assets going to his mother. His mother had 35 grandchildren and her estate plan left assets to them equally.

This beneficiary designation snafu thwarted the planning which had been done for John’s assets. Maybe John’s mother would agree to give the assets to John’s widow and children. But maybe she would not or could not due to incapacity. This highlights the need to examine beneficiary designations each time there’s any change. It also highlights the need to examine beneficiary designations periodically, when the plan is reviewed.

The Estate Planning attorney in this situation might get dragged in through no fault of their own. However, if they miss this designation snafu upon a review, they could have increased liability. It’s a best practice to get a copy of the beneficiary designation on each such asset and provide it to your attorney. Client’s often forget the designation they made because it could have been years earlier.

Beneficiary designations can be deceptively simple. Beware of the rest of the iceberg.