On December 20, 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 was enacted as part of the Further Consolidated Appropriations Act of 2020.  The SECURE Act is the most important retirement legislation since the Pension Protection Act of 2006. The intent of the SECURE Act is to make retirement plans more easily accessible to employees and less burdensome for employers.

For the most part the SECURE act has received a warm reception from the retirement industry, except for one provision – the death of the “Stretch IRA.”

The Stretch IRA

Under old law, upon death of an IRA holder, if the IRA passes to a non-spouse beneficiary, the non-spouse beneficiary generally was able to take annual required minimum distributions (“RMDs”) based off their life expectancy, as per a yearly table provided by the IRS.  In the case of a trust as a beneficiary, it was a 5 year rule.  Note – the stretch IRA was only relevant or NON-spouse beneficiaries since any spousal beneficiary would transfer the IRA to their name.

However, under the SECURE Act, the entire account balance must be paid out within 10 years of death for any non-spouse beneficiary regardless of whether death occurs before or after the RMD have begun. 

New Rules for IRA Owners

The new rules, which apply to any IRA whose owner died after 2019 and elect to leave any IRA to a non-spouse beneficiary (i.e. child) will have to be paid over 10 years.  Interestingly, the IRA does not have to be taken out in equal installments each year, but must be paid out in full by the 10^th year.  This change in the law has dramatically altered many retirement account holders estate and tax planning.

Under the old law, many IRA holders employed the use of a trust as beneficiary of their IRA for tax and also creditor protection.  The idea behind naming a trust as beneficiary of the IRA was that the trust would offer the IRA holder more control over how the IRA funds get distributed and also provide asset protection against creditors.

“See-Through Trust” (aka, Accumulation Trust)

Prior to the Secure Act, many wealthy IRA owners would often name a type of trust called a “conduit” or “see-through” trust as the account beneficiary. The main advantage of satisfying the “see-through trust” rules is that you will be allowed to stretch the IRA distributions over the life of a beneficiary instead of having to pay out the entire inherited IRA over 5 years.   In order to be treated as a “see-through trust” and qualify as a designated beneficiary, though, the trust must meet four very specific requirements, as stipulated in Treasury Regulation 1.401(a)(9)-4, Q&A-5:

1. The trust must be a valid trust under state law.
2. The trust must be irrevocable, or by its terms become irrevocable upon the death of the original IRA owner.
3. The trust’s underlying beneficiaries must [all] be identifiable as being eligible to be designated beneficiaries themselves. 
4. A copy of “trust documentation” must be provided to the IRA custodian by October 31^st of the year following the year of the IRA owner’s death.

If the four requirements listed above are met, a trust as IRA beneficiary can qualify as a designated beneficiary, and the RMDs associated with the inherited IRA can be stretched, based upon the life expectancy of the oldest trust beneficiary of the trust.

By contrast, any trust that can accumulate the RMDs as they leave the IRA, and might not subsequently pass them through to the underlying beneficiaries until some later date, is deemed an “accumulation” trust where both the current income and remainder beneficiaries must be considered.

However, under the Secure Act, the tax benefits of using a “see-through” trust is erased as the entire inherited IRA must be distributed over a 10-year period. 

But the use of an accumulation trust still offers some benefits.

The Accumulation Trust – Stretch IRA Workaround

Under an accumulation trust, the trustee is given discretion to decide whether to pay annual distributions to trust beneficiaries, or whether to keep that money out of their hands and protected in the trust instead. Though the new law requires all IRA assets to be paid into the accumulation trust within 10 years, the trustee can decide to spread withdrawals over a longer period — thereby keeping the original “stretch” concept intact, although not the tax benefits.

The way the accumulation trust strategy works, is that the IRA would be fully distributed to trust within 10 years.  Once the trust receives the IRA funds, the trustee of the trust will have more control over how the trust proceeds are distributed.  However, from a tax standpoint, all trust income on the former IRA funds would be subject to tax at the trust tax rates of 37%.  However, in the case of a Roth IRA, distributions of trust principal originating from the Roth IRA, should be tax-free to the trust beneficiary.

While the Secure Act provided many important benefits to retirement savers, such as the increase of the RMD age from 70 1/2 to 72, the elimination of the “stretch IRA” is a tough pill to swallow.