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.