With the SECURE Act now signed into law, it is critical to understand how it changes how we approach estate planning. Specifically, the SECURE Act replaces the “stretch” IRA from inherited retirement accounts, which allowed beneficiaries who inherited retirement accounts to choose to take distributions over their life expectancy. Under the SECURE Act, retirement assets must be distributed out of the account within 10 years of the account owner’s death. There are exceptions to the 10-year rule for spouses, minor children, and chronically ill or disabled beneficiaries, as well as beneficiaries not more than 10 years younger than the account owner (often a significant other or sibling).

Planning Appropriately For Wealth Transfer
This rule changes how we plan for the wealth transfer of retirement accounts to beneficiaries. Many revocable trusts will need to be reviewed to ensure they do not produce unintended consequences, especially those named as the beneficiary of a retirement account. Many revocable trusts contain conduit provisions, which cannot retain the assets that are distributed from the retirement account. The result is that the retirement assets will be forced out of the trust and into the hands of the beneficiary by the end of year 10. This could be problematic for clients who want to protect retirement assets for beneficiaries. 

For clients looking to protect their beneficiaries from receiving outright distributions of retirement assets, utilizing a retirement trust may be an ideal solution. Why would a client want to protect the assets? Maybe the beneficiary is a minor, a spendthrift, works in a litigious profession (doctor, lawyer, engineer, real estate, etc.) or a myriad of other reasons.

Protecting Assets With A Retirement Trust
A retirement trust is designed specifically to protect retirement assets for a beneficiary by navigating the nuanced retirement laws, such as the 10-year rule, and its various exceptions. At its core, a retirement trust allows a trustee to keep retirement assets in the trust. As a result, when the trustee receives distributions from a retirement account, they can determine when and how much of the funds are to be distributed to a beneficiary. This discretion allows a trustee to protect the assets when a beneficiary is going through a time of turmoil, such as a divorce, bankruptcy or any other creditor issue.

Reducing The Tax Impact With A Charitable Trust
Clients who are less concerned about protection, but care about reducing the negative tax impact from the 10-year rule, can name a charitable trust. A charitable trust allows the retirement assets to continue growing tax-deferred, even once the assets are distributed from the retirement account into the trust. Tax is paid only when the trust distributes income to the beneficiary (often a child or other non-charitable beneficiary). Essentially, the charitable trust creates the ability to regain the stretch IRA. When does the charity come into play? Generally, the charity is involved at the passing of the initial, non-charitable beneficiary, but it can also occur at the end of a term, for example, 20 years from the account owner’s passing. Whether it is at the end of a beneficiary’s life, or term, the charity receives the balance of the trust assets at that time. The only requirement is that the trust is designed to leave 10 percent of the initial contribution to charity.

A charitable trust is perfect for clients who want to minimize taxes for their beneficiaries and to provide for charity down the line.

Clients can also consider giving their retirement assets directly to charity upon their passing. While this achieves charitable giving and avoids taxation, it can result in non-charitable beneficiaries losing out on inheritance. This can be solved if a client purchases life insurance to replace the amount of retirement assets given to charity. Life insurance is beneficial because the life insurance funds are income-tax-free, and they can be sheltered in a trust to protect the assets for beneficiaries. 

The Advantage Of A Roth For Beneficiaries
Finally, a Roth conversion is a powerful wealth-transfer tool, as it creates a tax-free bucket of inheritance for beneficiaries. While traditional retirement accounts are subject to income tax upon distribution, Roth distributions are tax-free. A beneficiary inheriting a Roth IRA may still be subject to the 10-year rule, but the beneficiary will not have to pay taxes on any of the Roth distributions. Combining a Roth IRA with a retirement trust could create a tax-free, asset-protection vehicle that is perfect for beneficiaries.

By adding the above to the arsenal of retirement planning options, you can help clients navigate the new complexities of our retirement system. The first step will be reviewing retirement beneficiaries to make sure unintended consequences are avoided.

Jeremiah H. Barlow, J.D., is head of family wealth services at Mercer Advisors. Mercer Advisors provides comprehensive financial planning to individuals, families, endowments and foundations.