Proposed Regulations for SECURE Act Leave Things in Flux

If you are not sure how the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) will affect you, take Mark Twain’s advice on the weather in New England and wait a while. It could change again.

The SECURE Act was signed into law on Dec. 20, 2019, eliminating the so-called “stretch IRA” and seemingly settling the issue of distribution to beneficiaries and trusts of traditional IRAs. The act was modified with proposed changes in 2021 and dubbed SECURE Act 2.0. SECURE Act 2.0 never passed. Then, on Feb. 23, 2022, the IRS proposed a new set of regulations with respect to required minimum distributions (RMDs), leaving everything in flux again.

In previous articles, we discussed the 10-year distribution requirement for Non-Eligible Designated Beneficiaries inheriting from retirement account owners who died before their Required Beginning Date (which may ultimately increase to age 75) and those who inherited from retirement account owners who died on or after that date. The proposed regulations also challenge the understanding of what types of trusts can be named as beneficiaries of a retirement plan.

Naming a Trust as IRA Beneficiary is Rarely Simple

Even before the SECURE Act, naming a trust as the beneficiary of a retirement plan was fraught with error and confusion surrounding how the IRA proceeds must be paid to the trust. In general, the RMD payable to the trust was based upon the life expectancy of the oldest trust beneficiary if it was a properly drafted see-through trust. In a see-through trust, all the individuals counted as beneficiaries under IRS rules can be identified. Only individuals can be beneficiaries of a see-through trust. A trust that has a charitable beneficiary cannot be a see-through trust. What is at stake is how rapidly, and under what rules, the IRA or other retirement plan must be paid into the trust. This is true both pre- and post-SECURE Act.

The passage of the SECURE Act did nothing to clarify the confusion surrounding payout time frames and further enhanced the difficulty of naming a trust beneficiary. The SECURE Act’s distinction between an eligible designated beneficiary (EDB) and a designated beneficiary means the life expectancy of the oldest beneficiary could no longer be the measuring life of a properly drafted see-through trust. Post-SECURE Act, only a trust for the exclusive benefit of an EDB may have the life expectancy of that beneficiary used for the payout from the IRA. 

Also, the distinction of whether a properly drafted see-through trust is a conduit or an accumulation trust would take a new meaning. A conduit trust pays the proceeds from the retirement plan immediately to the beneficiary. In contrast, with an accumulation trust, the trustee can accumulate and hold the proceeds without having to pay it out immediately. With the SECURE Act, only a conduit trust may use life expectancy method (only if there is an EDB), while an accumulation trust cannot use the life expectancy method even if there is an EDB.

An accumulation trust is disqualified from using the life expectancy of the oldest beneficiary even if an EBD is the sole beneficiary. An accumulation trust must receive the distribution of all plan proceeds within 10 years of the participant’s death. The only exception to the conduit-only trust rule is for a special class of EDB – a person with a disability. 

As much as the proposed regulations infused uncertainty regarding RMDs, in some respects it isn’t all bad news. The SECURE Act allowed a life expectancy payout to an accumulation trust for only a disabled EDB, but the proposed regulations appear to allow the life expectancy payout for any EDB of an accumulation trust. No longer is only a conduit trust allowed for the life expectancy payout of an EDB.

Other Changes Affect Minors

Among the other proposed regulations: 

• For a minor child, an accumulation trust may be named beneficiary provided the trust fully distributes no later than when the EDB turns 31. This is true even if a charity is named the remainder beneficiary of this trust.

• A minor beneficiary is deemed to be any minor beneficiary and not just the minor child of the plan participant.

• The age of majority is 21.

• “Not more than 10 years younger” beneficiary is determined by actual birth dates, not calendar year.

• Remainder beneficiaries of conduit trusts continue to be disregarded.

The proposed regulations also address the situation where a see-through trust has at least one disabled or chronically ill beneficiary and the distribution rules to follow. It introduces a concept called an “applicable multi-beneficiary trust.”

If a trust also has power of appointment language, such that it may appear to fail the “identifiability” requirement of all trust beneficiaries by Sept. 30 of the calendar year following the calendar year of the plan participant’s death, the proposed regulations provide a Safe Harbor rule.

The proposed regulations also are taxpayer-friendly as they permit the amendment, modification, and reformation of trusts on or before Sept. 30 of the calendar year following the calendar year of the participant’s death so that beneficiaries, creditors, charities, and other entities can be added or removed. The designation of the beneficiaries and whether they are EDBs determines whether the trust can use life-expectancy payout rules or must fully be distributed by the end of the 10^th year following the calendar year of the plan participant’s death.

Key Takeaways

Essentially, a complete understanding of the SECURE Act is in a state of flux. The preamble to the proposed regulations states that in 2022 “taxpayers must apply the existing regulations” in addition to considering “a reasonable, good faith interpretation of the amendments being proposed.” By complying with the proposed regulations, taxpayers can satisfy this requirement. However, there are inconsistencies between the preamble, the proposed regulations, and the examples provided therein. 

While awaiting the needed clarity, plan participants and beneficiaries should carefully consider beneficiary designations, potential requirements to qualify a trust for stretching and update and take actions with respect to a qualified plan and IRA benefits going into trusts to protect wealth. Consult your advisor if you think your IRA planning needs revisiting in response to the proposals. 

Questions You Can Ask Your Advisor

1. Does this affect the “stretch” ability I thought I may have with the trust I named as beneficiary of my retirement account?

2. If the beneficiary of a retirement account is a trust, what type of trust is it?

3. Can you help me identify who are the countable trust beneficiaries?

For more information, please contact your Advisor.