This article examines the legal provisions regarding paying retirement to trusts that were unchanged and those that changed after enactment of the SECURE Act.
The SECURE Act has changed the legal landscape for paying retirement benefits to trusts. Gone, mostly, are distribution periods based on the life expectancies of various individuals, usually children and grandchildren. Not all of the rules of paying retirement benefits to trusts have been affected by the SECURE Act, however.
What Hasn’t Changed?
The treatment of inherited retirement benefits that are to be paid to a non-designated beneficiary (non-DB) upon the death of an owner of retirement benefits has not changed due to passage of the SECURE Act. First, it is helpful to understand what a non-DB is. A designated beneficiary (DB) is an individual designated as a beneficiary of a retirement account, a conduit trust, or a qualified accumulation trust. A non-DB is any beneficiary of a retirement account that is not a DB. Examples of non-DBs are estates, non-see-through trusts, and charities.
If the beneficiary of a retirement account is a non-DB, the distribution period depends on whether the owner died before or after his required beginning date (RBD). Under the SECURE Act, the RBD is now April 1 of the year after the owner turns age 72. Previously, the RBD was on April 1 of the year after the year the owner turned 70½.
If an owner dies before her RBD and the beneficiary is a non-DB, the distribution period will be 5 years, which starts on January 1 of the year after the owner’s death.
If an owner dies after his RBD and the beneficiary is a non-DB, then the distribution period will be based on the deceased owner’s life expectancy. To calculate the owner’s life expectancy, you must first determine the owner’s age had she lived the entire year. Next, you determine the owner’s life expectancy using the Single Life Table based on the owner’s oldest possible age if she lived the entire year. Finally, you subtract one from the figure obtained from the Single Life Table. This figure is the first “divisor” used to determine the minimum required distribution in the first year after the owner’s death. For every subsequent year, the “divisor” is reduced by one to calculate required minimum distributions in future years.
It is worth noting that the applicable distribution period for an inherited retirement account could be longer than 10 years if the owner dies after her RBD and the beneficiary is a non-DB. For example, if the owner dies in 2021 and would have been age 73 on December 31, 2021, had she lived the entire year, the applicable distribution period would be 13.8 years (based on the methodology explained immediately above). However, a minimum required amount will have to be distributed every year, which is not the case for the 5-year or 10-year withdrawal periods.
Again, the SECURE Act did not change these rules and concepts.
What Has Changed?
When it comes to paying retirement benefits to a see-through trust, the significant change ushered in by the SECURE Act is the elimination of life expectancy distribution period for most DBs. Before the SECURE Act, every single DB had a distribution period for an inherited retirement benefit based on a single life expectancy. Even if there were more than one DB named by the owner of a retirement account, each DB would receive a distribution period based on each DB’s life expectancy if separate accounts were created by December 31 of the year after the owner’s death. In reality, the creation of separate accounts often occurs very soon after an owner’s death.
The most impactful change imposed by the SECURE Act is a 10-year distribution period for most DBs instead of life expectancy. The 10-year distribution period starts on the first day of the year after the year of the owner’s death. Thus, for example, if an owner died on January 25, 2021, the first day of the 10-year distribution period will not start until January 1, 2022, and will not end until December 31, 2031. If the DB has not completely withdrawn the inherited retirement account by December 31, 2031, hefty penalties would be imposed. Similar to the 5-year distribution period mentioned above, there is no requirement that a specific amount be distributed from the inherited retirement account at any time during the 10-year term. The only requirement is that the inherited retirement benefit must have a $0 balance at the end of the 10-year term.
The SECURE Act created exceptions to the 10-year distribution period for a select group of “special” DBs, who are called “eligible designated beneficiaries” (EDB). A DB who is an EDB can receive a distribution period based on the EDB’s life expectancy as opposed to the 10-year term (which usually means a longer distribution period and a more favorable income tax outcome).
The following individuals qualify as EDBs under the SECURE Act:
(1) a surviving spouse;
(2) a minor child of the decedent (until the child reaches the age of majority at which point the 10-year rule kicks in);
(3) an individual with disabilities;
(4) a chronically ill individual; and
(5) an individual who is not more than 10 years younger than the decedent.
Again, EDBs are entitled to distribution periods based on their life expectancies.
Similar to the concept explained above to individuals, all see-through trusts (STT) (whether conduit or qualified accumulation) are DBs. But, not all STTs will receive EDB treatment. For a STT to receive EDB treatment, the STT must also qualify as an applicable multi-beneficiary trust (AMBT). An AMBT is:
(1) an STT (thus, it must satisfy the rules to qualify as a see-through trust — either conduit or qualified accumulation),
(2) have more than one beneficiary,
(3) the beneficiaries must be DBs (for the purpose of determing the distribution period), and
(4) at least one of the trust beneficiaries must be a “disabled” EBD or a “chronically ill” EDB as defined under the SECURE Act.
If a trust qualifies as an AMBT, there are two ways to have a distribution period based on life expectancy be put into place. First, if a trust has multiple beneficiaries, and the trust divides into separate trusts for each beneficiary upon the death of the retirement benefits owner, and there is a separate trust for a “disabled” EDB or a “chronically ill” EDB, the distribution period for the separate trust for the benefit of the “qualifying EBD” will be based on life expectancy.
Presumably, the distribution period will be based on the life expectancy of the “disabled” or “chronically ill” beneficiary who qualifies as an EDB. This would be the case if the AMBT qualifies as a conduit trust. If the AMBT qualifies as a qualified accumulation trust, the distribution period could be based on the life expectancy of either:
(1) the “disabled” or “chronically ill” individual who qualifies as an EDB, who would be the current beneficiary of the trust, or
(2) the life expectancy of the oldest “counted” remainder beneficiary (after applying the traditional rules for determining distribution periods to qualified accumulation trusts).
Second, if a trust qualifies as an AMBT and the trust’s beneficiaries are all either “disabled” and/or “chronically ill” to qualify as an EDB(s), the distribution period for the AMBT will be based on life expectancy. Presumably, the distribution period would be calculated based on the life expectancy of the oldest trust beneficiary.
In either type of AMBT, upon the death of or change in status of the EDB(s), the distribution period automatically changes from life expectancy to 10 years. This rule is similar to the rule explained above when no trust was involved.
Retirement benefits paid to trusts that are not see-through trusts, or, are non-DBs, continue to receive the same treatment as before the passing of the SECURE Act. Either the payout must be in 5 years if the owner died before her required beginning date or the payout will be based on the owner’s life expectancy.
Retirement benefits that are paid to see-through trusts (which are DBs) are subject to the 10-year distribution period or are subject to the life-expectancy distribution period. The only trust eligible to receive a life-expectancy distribution period is the applicable multi-beneficiary trust. The applicable multi-beneficiary trust must be drafted so it meets the technical requirements to qualify as such and it must also have as a beneficiary an individual who qualifies as an EDB by being “disabled” or “chronically ill.”