This is the second in a four-part blog series on the Setting Every Community Up for Retirement Enhancement Act (SECURE Act). Part 1, an overview of the act’s key provisions, can be read here. Future installments will cover minimizing the tax burden of the act’s 10-year payout and how it affects Qualified Charitable Deductions.

As we covered in the first part of this blog series, one of the key provisions of the recently enacted SECURE Act is the partial elimination of the “stretch” or “life expectancy payout” for beneficiaries of retirement plans. This week, we will look more closely at how that may affect your estate planning and what updates may be needed.

Previously, if the death of a plan participant or IRA owner occurred before 2020, beneficiaries were generally allowed to stretch out the tax-deferral advantages of the plan or IRA by taking distributions over the beneficiary’s life expectancy (the “stretch”). However, if the plan participant or IRA owner dies on or after Jan. 1, 2020, distributions to most nonspouse beneficiaries are required to be distributed within 10 years following the plan participant’s or IRA owner’s death. So, for those beneficiaries, the “stretching” strategy is no longer allowed.

Exceptions to the 10-year rule are allowed for distributions to “eligible designated beneficiaries” (the surviving spouse, a child who has not reached majority, a chronically ill or disabled individual, or any other individual who is not more than 10 years younger than the plan participant or IRA owner).

Many clients name trusts as beneficiaries of their retirement accounts, some of which are structured as “conduit trusts” (which under prior law qualified the trust for the life expectancy, or “stretch,” payout). A conduit trust requires all retirement account withdrawals to be paid directly to the beneficiary (or to a custodial account for a minor beneficiary). Most clients with conduit trusts, especially those trusts designed for non-eligible designated beneficiaries, will want to revise their estate plans to allow retirement account withdrawals to be accumulated in the trust for further protection.

For example, if you died this year with a $1 million IRA, and the beneficiary was a conduit trust for your 8-year-old son, then the trust would take withdrawals and make distributions based on your son’s life expectancy until he reached majority (which we will assume is age 18). The entire balance of the IRA would then need to be withdrawn within 10 years – by age 28. Due to the conduit trust terms, the entire balance of the IRA would be required to be distributed out of the trust to the 28-year-old whether or not he was prepared to handle it, even if there were potential creditors looming or he was in the middle of a divorce.

The alternative to a conduit trust is an “accumulation trust.” An accumulation trust allows the trustee to take withdrawals from a retirement account and accumulate the amounts in the trust, allowing distributions to be made to the beneficiary as determined by the trustee. Accumulation trusts may provide an advantage over conduit trusts as distributions may be made when appropriate based on the beneficiary’s needs, and amounts withdrawn from retirement accounts may be withheld if there are creditor issues or a threat of divorce. However, accumulation trusts can have some disadvantages.

Because retirement account withdrawals are generally taxable income (unless the withdrawal is from an account like a Roth IRA), the income will be taxable at the less favorable trust and estate tax brackets unless the withdrawal is distributed out to the beneficiary. The requirements to qualify as an accumulation trust are also complicated. Non-individuals, like charities, generally cannot be a beneficiary of an accumulation trust. Prior to the SECURE Act, accumulation trusts would also typically cause beneficiaries older than the current beneficiary, like older siblings, to be ineligible to receive retirement account assets on the death of a beneficiary. This restriction would allow the younger beneficiary’s life expectancy to be used for retirement account withdrawals. Certain existing accumulation trusts may need to be reevaluated to eliminate this potentially unnecessary restriction due to the 10-year payout applying regardless of the beneficiaries’ ages.

Certain special needs trusts for disabled beneficiaries that were designed as accumulation trusts should also be reviewed to confirm that they will qualify as an eligible designated beneficiary allowing a life expectancy payout.

Other clients who name adult individuals (not trusts) as beneficiaries of their retirement accounts may not need to change anything. However, this type of planning should still be reviewed, as leaving retirement assets in trust for a beneficiary can give them increased protection from creditors and in the event of divorce.

Another popular plan under prior law was to name grandchildren as beneficiaries of retirement accounts – due to their younger age, there would be a longer stretch. As grandchildren, even minor grandchildren, are now limited to the 10-year payout, this strategy should be reevaluated.

This is a good time to review the terms of your estate plan and all of the beneficiaries of your retirement accounts, life insurance, and other assets to ensure they are in order, tax-efficient, and consistent with the goals of your estate planning.