Estate planners are coming to grips with the changes to IRA tax planning brought about by the SECURE Act and tailoring solutions both big and small for clients.
The “explicit, stated purpose” of the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 was to raise revenue to finance the government’s expansion of participation in retirement plans, said Natalie B. Choate of Nutter McClennen & Fish LLP. “They want to get more money into retirement plans, so they can then sucker-punch the people in the plans by changing the distribution rules while the money’s already trapped in the plans, apparently,” she said during a January 8 InterActive Legal webinar.
Most of the sweeping changes in the estate planning world in recent years have been positive for taxpayers, Choate said, citing the doubled estate and gift tax exemption and the portability of that exemption. Other changes, such as new strict valuation rules, were purely prospective, applying only to gifts of property that had not been made.
In contrast, the changes wrought by the SECURE Act, which was part of a package of appropriations and tax legislation (P.L. 116-94) that President Trump signed into law in December, “are not benign,” according to Choate. The new law “affects not only people who are already dead, it affects the written estate plans that our clients have already made,” she said, adding that those plans relied on law that had been in effect for almost two decades.
The SECURE Act also marks a reversal in policy for Congress, Choate said. In 2009 Congress “slapped the wrist” of qualified retirement plans for not permitting life expectancy payouts by mandating that qualified plans with designated beneficiaries provide the option to transfer inherited qualified plan money into an inherited IRA, where they could get the life expectancy payout.
Now, with a few exceptions, Congress has taken that away, Choate said.
Different Strokes for Different Folks
The impact of the new tax law will be felt in different ways by different taxpayers, said Choate. “It’s definitely not one-size-fits-all, and there’s no one thing you can tell everyone to do,” she said.
Some clients won’t be affected at all; others will be affected in such a big way that “updating their estate plan is almost going to be an emergency,” according to Choate. For most clients, at least some changes and tweaks will be necessary, she said.
An IRA is a “big bag of taxable income,” and someone will have to pay those taxes — either the client or their beneficiaries after the client dies. And under the SECURE Act’s new 10-year mandatory distribution rule, for non-disabled adult children all IRA benefits must be distributed and taxes paid no more than 10 years after the death of the plan participant.
Some eligible designated beneficiaries, such as a minor child, a surviving spouse, or a disabled beneficiary, can get longer payouts, but the 10-year rule still eventually kicks in, Choate explained.
Some clients with a charitable bent may want to consider having a charitable remainder trust (CRT) as the beneficiary of an IRA. If the money in an IRA is left to a CRT, the whole plan goes into the CRT tax free, and it can then pay out a lifetime income to an adult child or other minor child beneficiaries, Choate said.
That strategy won’t be effective if the objective is purely to save taxes, according to Choate, but for clients with charitable intent, it’s an effective way to combine achieving charitable goals while also providing a child who, “if you give him a dollar outright, it’s gone by sunset,” with a stable lifetime income that can’t be spent all at once.
Brandon L. Ketron of Gassman, Crotty & Denicolo PA similarly suggested that taxpayers might consider giving the beneficiary of an IRA the right to disclaim that IRA and have it pass to a public charity or family foundation. Doing so could result in the equivalent of a charitable deduction for retirement assets that otherwise wouldn’t apply because of the increased standard deduction, he said during a January 9 Leimberg Information Services Inc. webinar.
“I think a lot of clients, as a result of the SECURE Act, are going to be reaching to charity,” said Alan S. Gassman of the same firm. As clients age, they become more affluent, and their children grow older and become more self-sufficient — or they start to resent their children who aren’t self-supporting, he said.
Disclaimers allow flexibility for a surviving spouse to disclaim it to the children, who could also then disclaim it to charity, Gassman said.
‘I’m a Little TEA Pot . . .’
A new trust arrangement that has sprung up in the wake of the SECURE Act is what Gassman calls the twin tax-efficient accumulation (TEA) pot trust system.
Gassman explained that this arrangement involves two pot trusts — a type of trust in which the trustee has discretion over how to distribute funds to the child beneficiaries of the trust. One of the TEA pot trusts receives the entire IRA plan after the death of the plan participant, and the trustee has the power to distribute the IRA’s income in the most tax-efficient manner among the beneficiaries after taking into account factors like the beneficiaries’ tax brackets.
A second pot trust, the equalization trust, is then established to hold assets that do not generate high levels of income, such as municipal bond funds. The assets in that trust “can cook for 10 or 11 years,” Gassman said, and at the end of that period, the trustee then makes distributions from the equalization trust to the beneficiaries in higher tax brackets to make up for the distributions that were made to beneficiaries from the first pot trust. That way, assets are distributed equally among the client’s beneficiaries in a tax-efficient way.
“The beauty of the TEA pot trust is we have flexibility,” said Christopher J. Denicolo, also of Gassman, Crotty & Denicolo. If a child beneficiary in a low tax bracket suddenly becomes gainfully employed and starts to make a lot of income, the trustee can readjust the distributions accordingly.
“We think it's a great idea for clients who in prior law would have left [an IRA] to trusts equally,” Denicolo said. “Now we have the flexibility to leave the assets to trusts equally by using non-IRA assets to equalize.”
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