The Secure Act became law on December 20th, 2019, bringing the most significant changes to the retirement system in over a decade. Among the changes is the end of the so-called 'Stretch IRA' which allowed non-spouse beneficiaries of an IRA (or other type of retirement account) to 'stretch' withdrawals over their lifetime by taking required minimum distributions (RMDs). Starting in 2020, retirement accounts inherited from a non-spouse (e.g. parent or relative) must be taken in full within 10 years. Account owners who named a trust as their primary or contingent beneficiary may need to rework their estate plan to avoid further negative implications for their heirs.
The old rules for inherited retirement accounts (enter the 'Stretch IRA')
Prior to the passing of the Secure Act, most non-spouse beneficiaries who inherited any type of IRA, 401(k), 403(b), or other type of defined contribution plan could withdraw the funds by taking required minimum distributions (RMDs) over their lifetime (the IRS' uniform lifetime table provides a life expectancy based on a person's age).
Solo non-spouse beneficiaries of an account would be able to take RMDs over their life expectancy. If the account was left to multiple non-spouse heirs, RMDs would be based on the life expectancy of the oldest one, unless separate inherited IRAs were established by 12/31 of the year following the year the decedent passed away.
Naming a trust as beneficiary of a retirement account (under the old rules)
In general, one of the greatest benefits of naming a trust as a beneficiary or putting an asset in trust is having more control. In one of the more common examples, parents with young children often prefer to name a living trust as contingent beneficiary of their retirement accounts in case they pass away along with their spouse.
Rather than give unfettered access to caretakers or an 18-year-old child, the trust could be set up to only allow trust beneficiaries to take their annual required minimum distribution. Access to additional IRA funds could be restricted until the beneficiary reached a certain age. This strategy could help protect the inheritance in the instance of divorce, creditors, mismanagement, reckless spending, and so forth.
The new rules for retirement accounts inherited by a non-spouse
Adults who inherit a retirement account from a parent, relative, or other non-spouse individual will no longer be able to take distributions over their lifetime if the decedent passed away on/after January 1st, 2020. These inheritances will now need to be depleted by the end of the 10th year following the passing of the decedent. There are no required distributions (e.g. RMDs) within the 10-year period, so the amount and timing of the distribution(s) within this window is about the only thing left for most beneficiaries to control.
There are three exceptions to the new rule. Minors will have until they reach the age of majority (age 18 or 21, depending on the state) before the 10-year payout period begins. The new 10-year distribution rule will also not apply to beneficiaries less than 10 years younger than the decedent or if the beneficiary is disabled or chronically ill (per IRS definition). These beneficiaries will still be able to withdraw the funds over their lifetime using the 'old' rules.
For clarity, the new 10-year rule does not apply to inheritances left during 2019 or years prior, nor does it apply to inheritances (past or future) left between spouses.
If you’ve named a trust as a beneficiary of your IRA or retirement account, take action
The death of the 'Stretch IRA' may be significant for individuals using a trust in their retirement estate plan. It is strongly advised that you speak with your estate planning attorney to understand how the new law may change your existing strategy and if changes should be considered to your overall legacy plans for heirs.
As previously discussed, one of the main reasons to name a trust as the beneficiary of your IRA is to have more control over the payment terms. If the terms of your trust specify that heirs can only receive required minimum distributions, beneficiaries may have to take their entire share of the account at once in year 10 under the new law. Since the Secure Act did away with RMDs for most non-spouse beneficiaries, there's really only one point during this window when distributions are, in fact, required, which is at the end when the account must be depleted.
Aside from the fact that taking the funds at once could be a tax-fiasco for heirs (and particularly for adult children during their prime working years), there's no reason to think this outcome was intended when the trust was named.
If you've named a trust as a primary or contingent beneficiary of a retirement account, review the terms of the trust and discuss your options with your estate planning attorney. You may want to change the payout terms in the trust to offer beneficiaries more flexibility, but depending on the situation and your goals, this may negate the purpose of using a trust in the first place, instead of just naming your beneficiaries outright.
Also read our article in Forbes on Strategies for Account Owners and Beneficiaries in Light of the 10-Year Payout Rule
We plan, God laughs
As you consider whether to make any changes to your estate plan, take a moment to reflect on your whole financial picture and the factors that are up to you to control. The major changes included in the 2019 Secure Act follow numerous other big shifts in tax law from the Tax Cuts and Jobs Act at the end of 2017. In the current political environment, more changes to the tax and retirement system could come at any time, which is worth keeping in mind as you weigh the cost, benefits, and flexibility of new legacy planning strategies.