Q&A with Paul Caspersen with excerpts from his e-book The SECURE Act & Proposed Regulations: How to Plan Now

Why are retirement assets unique in the estate planning process? 

Generally speaking, IRAs, 401(k)s, and other retirement plan assets do not pass under the client’s will or trust terms but instead transfer to whoever is named in the IRA beneficiary designation. The most common designations are to individuals, such as a spouse or in equal shares to children. However, a trust also can be named as an IRA beneficiary, and in many scenarios, a trust is a better option than naming an individual.

The Baby Boomers are the first generation with a significant amount of retirement plan assets to consider in their estate planning. The Employee Retirement Income Security Act of 1974 (ERISA) is considered one of the primary explanations for why defined-benefit (DB) plans peaked by 1985 and today are nearly extinct. Most Boomers have participated in a defined-contribution (DC) plan throughout their careers. They’re the first generation to have accumulated a significant amount of their wealth in retirement plans, and most clients (and sometimes advisors) underestimate the complexity these assets add to the estate-planning process. To understand this monumental change to estate planning, consider that in 1974, only 18% of all retirement assets were held in DC plans and IRAs (62% were in DB plans), and by 2019, more than 60% were in DC plans. Ten thousand Baby Boomers are retiring every day, and the Boomer Generation at large have greater than $30 trillion in retirement assets.

Before 2020, a “stretch” IRA, where the beneficiary took distributions from the IRA over his or her lifetime, was a useful estate-planning tool because the longer the IRA lasts, the more investment growth can be shielded from taxes. Following the SECURE Act, IRA owners must consider the income tax implications to their beneficiaries. Funding a testamentary CRT using retirement assets to create an automatic stretch IRA is one planning strategy that will be addressed in this paper. 

Why is the SECURE Act such a dramatic change to estate planning with retirement plan assets? 

The SECURE act does not amend or replace section 401(a)(9)(B) or any of the existing regulations, nor does it change the definition of a designated beneficiary. The SECURE act adds a new section to 401(a)(9) and 401(a)(9)(H). Section “H” layers, on top of the existing rules, new payout periods that will pertain to all designated beneficiaries. The ten-year payout replaces the life expectancy payout method for all but five types of “eligible designated beneficiaries,” who are still entitled to a life expectancy payout. 

By adding five categories of eligible designated beneficiaries who are not subject to the ten-year rule and four different sets of minimum distribution rules within those five categories, planning is considerably more complicated.

Because retirement assets are typically the most significant asset in an individual’s estate, special planning is required to ensure the beneficiaries inherit these assets most optimally, customized for each beneficiary. Before 2020, retirement assets could be payable to a see-through trust. These IRA trusts are known as either conduit trusts or accumulation (or discretionary) trusts.

With a conduit trust, RMDs are paid from the inherited IRA to the trust and distributed to the trust beneficiaries annually. Under the old rules, if the IRA trust qualified as a see-through trust, the trust beneficiaries were treated as if they were named directly, and the stretch payout was permitted. With a conduit trust, the beneficiaries paid tax on the RMDs at their own tax rate.

In 2020 and beyond, the problem with the conduit trust is there are zero RMDs, and at the end of the ten years, the entire balance in the inherited IRA would be paid out to the beneficiaries. This leaves no funds remaining protected in the trust after ten years and leaves beneficiaries with a mega tax bill.

With an accumulation trust, the trustee has the discretion to decide whether to pay out the RMDs immediately to the trust beneficiaries or instead retain the assets in the trust to preserve the funds, so the funds could remain in the trust and be protected, but at a cost. If an accumulation trust is a beneficiary, then all of the inherited IRA funds would have to be paid to the trust by the end of the ten years. After those ten years, the entire trust would be taxed at federal trust tax rates, which are taxed at 37% over just $12,950 of income in 2020.

The post-death RMDs for a trust named as an IRA beneficiary will be calculated under either the stretch payout rule, the ten-year rule, or the five-year rule, depending on specific attributes of the trust and the trust beneficiaries.

The proposed regs for the SECURE act announced in the spring of 2022 help to clarify possible effective trust planning for retirement assets beyond 2020.  

What type of non-charitable planning techniques should advisors consider? 

For starters, Roth IRA conversions. While the so-called death of the stretch has certainly limited some benefits of a Roth conversion to bequeathing an IRA to an heir, this planning opportunity remains an effective strategy for many. Scenarios where it makes sense to consider a Roth conversion include instances where taxes on the conversion can be paid with funds outside the account, and the account owner will not need to access the account within their own life, or where individuals can make piecemeal conversions over multiple lower-income years to convert cheaply, taking advantage of lower marginal tax rates. Another factor advisors should consider when deciding whether a Roth conversion makes sense is simplifying future decision-making for beneficiaries.

Determining the most tax-efficient approach to draw down the account for large traditional IRAs may prove challenging. In most cases, absent any past nondeductible contributions, distributions from inherited traditional IRA accounts will be fully taxable to beneficiaries. This is especially true for beneficiaries in their prime earning years.

Roth IRA beneficiaries will inherit a much more straightforward tax-planning situation than beneficiaries of traditional IRAs. While they will still be subject to the ten-year rule, distributions from the account will not be taxable. Most beneficiaries will likely leave the entire balance under the protection of the account for the ten years to achieve maximum growth with minimal income tax consequences.

Though considerations around Roth IRA conversions have changed due to the SECURE Act, Roth IRAs still offer advantages to account owners and beneficiaries. Roth IRAs are tax-advantaged, and owners of Roth IRAs are not required to take RMDs. This can prove helpful in retirement, as it allows a more significant amount of assets to remain in the account. Not taking RMDs can also help account owners avoid creating unwanted taxable income, giving them more flexibility in retirement. Beneficiaries will enjoy a more straightforward tax situation versus beneficiaries of traditional IRAs due to the tax-free nature of the distributions from the account.

Advisors with clients who made Roth conversions before the SECURE Act should also ensure that any account beneficiaries named as part of the initial conversion planning, especially any younger individuals, are still suitable to accomplish planning goals.

What type of charitable estate planning for retirement plan assets should advisors become familiar with?

Charitable Bequest of Retirement Assets: As a basic rule, if the donor’s estate is large enough to provide both for individual heirs and charitable gifts, the best strategy is to leave income in respect of a decedent (IRD), such as retirement plan assets, to charity and leave individual beneficiaries the non-IRD property, which receives a stepped-up basis at death under 1014(a). 

Testamentary Charitable Remainder Trust Funded with Retirement Assets: Naming a charitable remainder trust may increase the tax savings for beneficiaries compared to using the new ten-year rule for distributions. Individuals who leave a surviving spouse have most, but not all, of the same stretch IRA options they had before 2020. The surviving spouse can still roll the IRA over to their own IRA and not take distributions until age 72. 

Many advisors believe that the concept of leaving retirement assets to a testamentary charitable remainder trust (TCRT) is very difficult to explain to the average client. However, the alternative is trying to explain how see-through trust planning works (that often includes eligible designated and regular designated beneficiaries under the SECURE Act.) Advisors will find, in this case, that explaining the approach of a TCRT can be extremely straightforward!

For donors who wish to provide for charity with an estate gift and establish a reliable income stream to one or more heirs, using retirement plan assets to fund a TCRT can effectively accomplish both goals. In a series of favorable private letter rulings, the IRS determined this transfer would not trigger federal income tax on the entire balance. Instead, the income tax is applied only as this income is distributed individually to the income beneficiaries of the CRT.

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