by Bryan Allee, J.D. – Senior Vice President & Chief Fiduciary Officer

The rules regarding withdrawals from inherited IRAs dramatically changed for IRA beneficiaries with the SECURE Act, passed just before the beginning of 2020. Before the SECURE Act, nearly every individual beneficiary of an IRA could choose to take required minimum distributions [RMDs] based on his or her individual life expectancy, creating what is often referred to as a “Stretch IRA.” For the average person inheriting the IRA as an asset, this permitted the beneficiary to “stretch” the tax consequences of taking RMDs, and to allow the IRA assets remaining inside to grow tax-deferred, for significant periods of time.

Even more beneficial, before the SECURE Act, inherited IRAs could be left in a discretionary trust structured in such a way that the IRS would treat it as a “see-through trust”– meaning that even though the IRA was held as an asset of a trust, the life expectancy of the primary beneficiary of the trust could be used to achieve the same “stretch” result as if the deceased IRA owner had named that person to get their share of the IRA outright. Although somewhat limited in its benefit under the rules regarding income taxes for trusts, this gave many IRA owners a way to both: (a) have a trustee control the distributions of IRA funds going to the beneficiary; and (b) still limit the amount of income tax paid on withdrawals from the inherited IRA during the term of the trust. For many people making their estate plans, it seemed like this combination was a “match made in heaven.”

With the new rules after the SECURE Act, the use of the “Stretch IRA” over a beneficiary’s lifetime is much more limited. Only certain specific classes of beneficiaries (surviving spouses or disabled persons, for example) are now able to qualify as “eligible designated beneficiaries” under the SECURE Act to get “Stretch IRA” treatment. For most other individual beneficiaries, the new rules create a “10-year payout” requirement – the beneficiary inheriting their share of the IRA must receive all of its proceeds by December 31 of the tenth year after the IRA owner dies. And consequently, this limitation carries over for “see-through trusts.” As a result, the tax deferral that lasted 30, 40 or 50 years into the future for most trust beneficiaries, has now given way to the 10-year payout required under the new SECURE Act rules. Thus, the tax costs of holding those inherited IRA withdrawals inside the trust can be significantly higher.

So, should you remove your trust as the beneficiary of your IRA? The lawyerly answer is, of course, “It depends.” Several considerations would be worth evaluating when deciding whether there are better ways to pass your IRA assets at your death. First, consider how much of your total net worth is in IRA assets versus non-IRA assets. For owners with small IRAs, there may not be great concern about the tax effects beneficiaries may suffer with their share of an inherited IRA. Generally speaking, owners who have large IRAs or who have a significant amount of their total wealth in IRAs, 401(k)s, or other “qualified assets,” should look very closely at their current plans. The change from RMD withdrawals before the SECURE Act to 10-year payouts after the SECURE Act creates greater tax consequences as the total amount of IRA assets increases. One planning possibility for large IRA owners would be to consider “splitting up” IRAs into smaller pieces for more beneficiaries (grandchildren as well as children, perhaps even charities) to avoid the consequences of a high tax burden on any one beneficiary.

Second, consider how important it is for an individual to inherit their share of the IRA directly versus inheriting the share through a trust indirectly. IRA owners often use a trust as a way to protect the inherited IRA asset (and the trust’s beneficiary) from third-party claims – divorce, lawsuits, or bankruptcy, to name a few. Or perhaps just as important, owners may want to remove from a beneficiary the temptation of taking money out of the inherited IRA for what may be frivolous spending. In Missouri, unlike many other states, inherited IRA accounts that hold assets for a beneficiary are exempt from the claims of creditors.

But that protection is only as good as the ability and the desire of IRA beneficiaries to refrain from taking IRA assets out for themselves. Once funds are withdrawn from the inherited IRA, they are in the hands of the beneficiary and are fair game to third parties. And with the SECURE Act’s 10-year payout rule, that withdrawal happens much faster than it might if a trustee held those IRA assets in trust over time for payment to a beneficiary at the trustee’s discretion.

Finally, for persons who own large IRAs and want to maximize tax deferral, while still providing benefits to their children or grandchildren, there is a special type of trust that may provide some measure of both. More estate planning attorneys are recommending the use of a charitable remainder unitrust [“CRUT”] to pass IRA assets to individual beneficiaries for a period of time (possibly even for their lifetime) with the remainder going to a charity at the beneficiary’s death. By use of the special deferral benefits provided for CRUTs, this can increase the tax deferral for inherited IRA assets for an individual beneficiary beyond the 10-year payout rule, maintain protection of the IRA asset from third-party claims while in trust, and ultimately benefit a charity of the owner’s choice after the individual beneficiary dies. The downside to such a plan is the added level of complexity and structure needed to create CRUTs for individual beneficiaries (as well as the added legal costs in creating them).

These considerations are complicated and vary greatly depending on the ultimate goals you have for transferring your wealth at death. But the bottom line is this: if you have named your trust as the beneficiary of an IRA, you should review your estate plan with your attorney. Right away.

At a minimum, contact one of our staff at Central Trust Company to look at your current plan for passing your IRA at death to see if there are other options you should consider. We may be able to find some creative solutions to deal with the consequences of the new SECURE Act rules as they impact your IRA assets. It could make a big difference for your family’s financial future.