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Speaking at the 2020 ASNP Annual Meeting, ASNP member Melanie Marmion discussed how the SECURE Act’s new rules regarding retirement accounts are “a game changer” for special needs planning. In her presentation, “SECURE Act and Special Needs Planning: The Latest Updates,” Marmion deftly guided listeners through the complex rules for transferring retirement accounts upon the owner’s death, the optimum use of trusts for receiving retirement funds, and other estate planning considerations.

The ”Stretch”

Before the SECURE Act was signed into law on December 20, 2019, those inheriting money from a retirement account could reduce tax consequences by withdrawing minimum required distributions over their life expectancy, a practice known as “the stretch.” Congress’s long-time desire to “kill the stretch” finally got traction and the SECURE Act was passed.

Broadly speaking, the Act does a number of things:

  • Expands distributions from 529 education plans
  • Changes the date for minimum distributions to age 72
  • Eliminates the age cap on contributions to IRAs
  • Permits small businesses to band together to create a 401(k) for employees
  • Kills the stretch payout rule for most beneficiaries inheriting retirement plans
  • Establishes a new category of inheriting beneficiary – the Eligible Designated Beneficiary (EDB)

Beneficiaries Under SECURE  

Three types of beneficiaries may now inherit a retirement account. Non-designated beneficiaries (NDB), designated beneficiaries (DB), and EDBs, each subject to their own set of rules regarding payout from the account. (See Marmion’s materials for a chart summarizing the three types of beneficiaries and their applicable rules.)

NBDs can be an estate, a charity, or an opaque trust. They must take their distributions from the retirement account within five years if the owner of the account was younger than age 72 at death, or, if the owner of the account was age 72 or above at death, the beneficiary may take its payout over the decedent’s life expectancy (the “ghost expectancy rule”).

BDs can be an individual, or a see-through accumulation or conduit trust. They are now subject to a 10-year payout period, an accelerated timeframe under the SECURE Act. Given differences between the trusts, Marmion explained, a settlor may prefer one over the other. In accumulation trusts, the trustee controls the money received and can determine when and how much to distribute to the beneficiary; however, these trusts are subject to compressed tax rates that can result in paying taxes that amount to approximately 46 percent of the distribution. For clients wanting accumulation trusts, control should be more important to them than the taxes, Marmion said.

Conduit trusts are the opposite. The trustee is required to select a minimum distribution and pay it immediately to the beneficiary. Unless the beneficiary of the conduit trust is an EDB, the payouts to the beneficiary must be completed in 10 years, using whatever schedule the trustee and/or beneficiary may determine. Here, the individual is taxed at the lower individual income tax rate of approximately 30 percent.

EDBs can be a surviving spouse, a minor child of the account owner, one with a disability (SNT) or who is chronically ill, or one who is not more than 10 years younger than the account owner. “Disabled” and “chronically ill” are defined by the Act. EDBs are now the only beneficiaries who get the life expectancy, or “stretch,” payout rule, except that when EDB status ends for a beneficiary, the 10-year payout rule kicks in for the amount remaining in the retirement account. “One quirk in the way the legislation is written, it appears that in order to get life expectancy payouts for a minor’s trust, the trust must be designed as a conduit trust,” said Marmion. The reference in the statute is ambiguous enough that further clarification is needed, but, until then, trusts for minors must be conduit trusts. Accumulation trusts will generally not qualify as an EDB unless the primary beneficiary is either disabled or chronically ill.

See-Through Trusts

Conduit and accumulation trusts are the two types of see-through trusts. To qualify as see-through trusts, the following five requirements must be met:

  • Trust must be valid under state law
  • Trust must be irrevocable
  • A copy of the trust must be provided to the retirement plan provider no later than October 30th of the year following the owner’s death
  • All “countable” beneficiaries of the trust must be identifiable
  • All “countable” beneficiaries of the trust must be individuals

In conduit trusts, the primary beneficiary is an individual, subject to the 10-year payout rule, unless the primary beneficiary is an EDB, who is then subject to the life expectancy payout rule. Income taxes are paid by the beneficiary.

Conduit trusts must be drafted to specifically require immediate distribution of withdrawals from the retirement account to the lifetime beneficiary. There must be conduit-specific language, not a general reference to “all income.” All funds from the retirement account must be transferred out to the beneficiary by year 10, except in the case of a minor, as long as the individual is a minor.

In accumulation trusts, the 10-year payout rule applies unless all countable beneficiaries are EDBs or the sole lifetime beneficiary has a disability and the trust is an SNT. Funds from the retirement account must be paid to the accumulation trust within 10 years. Income taxes are paid at the higher trust rate, unless the trustee distributes it out to the beneficiary in the same year.

An accumulation trust is any trust not designed as a conduit trust wherein all the “countable beneficiaries” are individuals. Use the “chain” test to determine which beneficiaries count: The current beneficiary is the first link. Pretend that beneficiary dies and count all remainder beneficiaries of the trust until reaching the last one entitled to receive the trust property upon the death of the prior beneficiaries. If any of those beneficiaries are a charity, or not an individual, the trust is not a see-through accumulation trust and may be subject to a five-year or ghost expectancy payout, which may be fine if the settlor prefers that the trustee maintains control of the money.

SNTs

Accumulation trusts are still very important for SNTs. SNTs are an EDB and will receive a life expectancy payout if:

  • The primary beneficiary has a disability
  • The beneficiary with a disability is the sole lifetime beneficiary; and
  • The SNT otherwise qualifies as a see-through accumulation trust

As an EDB, the SNT will receive payouts from the retirement account over the primary beneficiary’s life expectancy, enabling stretch out of the tax consequences.

Estate Planning Ideas

When allocating specific assets across multiple beneficiaries, one of whom has disabilities, retirement funds should be allocated to an SNT to benefit from the long EDB payout period. Mindful that specific assets designated to specific beneficiaries may not be truly “equal” as fluctuations in asset values occur, an equalization clause can help adjust for those fluctuations by gifting money to the SNT from the probate estate. This works only when the probate assets exceed the value of the retirement account and the equalization is written into the settlor’s will.

A Charitable Remainder Trust (CRT) may also achieve the settlor’s desired outcome when she wants to benefit a charity. Accumulation trusts cannot have a charity as a beneficiary, while conduit trusts give up control. A CRT will receive the distribution from the retirement account without tax and can pay out a fixed annuity to the beneficiary. A charity must receive 10 percent of the initial value of the CRT.

Finally, Marmion suggested considering a trust even if the beneficiary is financially capable. If the trust has a single lifetime beneficiary, that beneficiary experiences a disability, and all countable remainder beneficiaries are individuals, then the trust is an EDB.

Post-Death Fixes

Post-death fixes to create better outcomes remain under the SECURE Act. Generally, multiple beneficiaries of a retirement account are analyzed as a group. One NDB, such as a charity, in the group results in the entire group’s ineligibility for DB and EDB status. The September 30th Rule allows the NDB to be eliminated from the group before September 30th of the year following the account owner’s death, permitting the remaining beneficiaries to receive DB or EDB status if they qualify.

The Separate Accounts Rule permits individual beneficiaries in a beneficiary group to set up separate accounts to receive their share. Accounts must be established by December 31st of the year following the account owner’s death, and each account will apply its own appropriate payout rule. The Separate Accounts Rule does not apply to trust beneficiaries when a revocable trust is named as the primary beneficiary, except that an SNT can separate itself and use the EDB rule.

Game Changer

Marmion concluded her presentation agreeing with ASNP national director Kevin Urbatsch that the SECURE Act is a “game changer” for beneficiaries with special needs and special needs planning, and that revising some pre-SECURE Act plans could result in significant benefit to some beneficiaries.

To view Marmion’s presentation and access her materials, click here and scroll down to Session 7.