The ABCs of Estate Planning for IRAs Under the Secure Act

Get Morningstar's essential reading for financial professionals in Advisor Digest.

The Secure Act of 2019 created a confusing new array of different “required minimum distribution rules” for “plain old designated beneficiaries” and five classes of “eligible designated beneficiaries." Meanwhile, the IRS’ complicated “minimum distribution trust rules” are still with us, even though the rewards for successfully navigating the same are diminished.

The “ABC” (and sometimes “D”) system described here is designed to cut through that confusion and get you quickly to the estate planning options for each type of beneficiary and their minimum distribution consequences. The client has only four options for how he can leave his IRA to any beneficiary. The ABCD approach gets you instantly to the RMD effect of each approach. Here goes:

In the client's beneficiary designation form for the client's IRA: A: The client names the beneficiary directly. B: The client names a "conduit trust" for the beneficiary. C: The client names a see-through accumulation trust for the beneficiary. D: See the end of this article.

What’s the effect of each choice on the beneficiary’s payout options?

A. Naming the beneficiary directly.

As in “I name as my beneficiary my daughter Susie” or “my husband, Harry.”

The beneficiary will get the best possible “deal” available for his or her category under the minimum distribution rules. That means for a disabled or chronically ill individual, or any individual who is not more than 10 years younger than the participant, the life expectancy payout. For the participant’s minor child, it means a life expectancy payout during minority, flipping to the 10-year rule upon attaining majority. For the "plain old designated beneficiary" (an individual who does not fit into any of the “eligible designated beneficiary” categories), it means the 10-year rule.

And for the surviving spouse, it means all the special spousal “deals” apply--the life expectancy payout (with life expectancy recalculated annually, and the start of distributions delayed until the decedent would have reached age 72) and the spousal rollover (the spouse can roll the benefits over to his or her own IRA, delay distributions to age 72, and take distributions using the Uniform Lifetime Table rather than the Single Life Expectancy Table).

Of course, naming the beneficiary outright has drawbacks. It’s not feasible for a minor child, assuming the client wants to keep the asset protected in trust past the minor’s attainment of majority. It won’t work if the beneficiary is disabled and the client wants to name a “supplemental needs trust” so the beneficiary does not lose qualification for means-tested government benefits. It’s not best for the client who does not want this beneficiary to have outright ownership for any reason. So, we move to the next level:

B. Naming a conduit trust for the beneficiary

Under a “conduit trust,” the trustee is required to pass out to the human beneficiary of the trust all distributions the trustee receives from the IRA during that beneficiary’s lifetime. That would mean the trustee must pay out to the beneficiary (or apply for the beneficiary’s benefit) all required minimum distributions paid to the trust as well as any other distributions the trustee withdraws from the IRA. These “additional distributions” would be whatever additional distributions (if any) the trust instrument directs or permits the trustee to withdraw, such as distributions “for health or support” or “in the trustee’s discretion.”

Although “conduit trust” is not an official term, the IRS has given this type of trust a special status under the minimum distribution rules: The individual beneficiary of the conduit trust will be treated, for all purposes of the minimum distribution rules, as if he or she is the sole beneficiary of the IRA, even though there is a trustee in between that beneficiary and the IRA.

Thus, a conduit trust for a beneficiary will be entitled to exactly the same minimum distribution deal such beneficiary would have received if named directly. If the conduit beneficiary is disabled or chronically ill or is not more than 10 years younger than the client, the conduit trust gets the life expectancy payout. For the client’s minor child, it means a life expectancy payout during minority, flipping to the 10-year rule upon the child’s attaining majority. For the "plain old designated beneficiary," it means the 10-year rule.

For the surviving spouse, it means the special spousal “deals” apply--the life expectancy payout with the spouse’s life expectancy recalculated annually and the start of distributions delayed until the decedent would have reached age 72. However, one deal is lost--the spousal rollover cannot be used with a conduit trust. The spousal rollover is not part of the minimum distribution rules and is only available for benefits the spouse can withdraw at will.

The conduit trust does not solve all problems. It does not work for the client who wants to leave benefits to a supplemental needs trust for a disabled or chronically ill beneficiary or who, for whatever reason, does not want the beneficiary to get this much control. For example, the conduit trust would distribute the entire account outright to a “minor child of the participant” within 10 years after the child reaches majority. A "plain old designated beneficiary" would get outright control no later than 10 years after the client’s death.

What other options are on the menu?

C. Naming a see-through accumulation trust for the life benefit of the beneficiary

The STAT is a few steps more complicated and restrictive than the conduit trust. Instead of being required to pass through all IRA distributions immediately to the life beneficiary, the trustee has discretion to hold on to (“accumulate” in IRS terminology) the IRA distributions for distribution in a later year to the beneficiary or to other individuals after this beneficiary’s death. This allows the client (through the trustee) much greater control over distribution of the benefits to the individual beneficiary.

For some (not all) beneficiaries, there is a big trade-off for retaining this much control: A STAT is generally subject to the 10-year rule. It cannot qualify for the life expectancy payout for any beneficiary other than a disabled or chronically ill individual. So, using a STAT instead of a conduit trust changes the payout period for these beneficiaries:

• A STAT for the surviving spouse is stuck with the 10-year rule, even if it qualifies for the marital deduction. No spousal rollover, no life expectancy payout.
• A STAT for an individual who is "not more than 10 years younger" (that is, is older than, the same age as, or younger than the participant, but not more than 10 years younger) (and who doesn't fall into any of the other categories of "eligible designated beneficiary") is stuck with the 10-year rule. No life expectancy payout.
• A STAT for the participant's minor child is stuck with the 10-year rule, too. No life expectancy payout even during minority.

Here are the exceptions: These are situations where the STAT is or might be just as good as a conduit trust in terms of minimum required distribution results:

• A STAT for the sole life benefit of a disabled or chronically ill individual still qualifies for the life expectancy payout. This type of trust is called an "applicable multi-beneficiary trust" (don't ask me where they got that name) and enables the client to name a supplemental needs trust for the disabled beneficiary and still qualify for the life expectancy payout.
• For the "plain old designated beneficiary," the 10-year rule applies whether you leave the benefits outright to the individual, to a conduit trust for him or her, or to a STAT for his or her benefit. So, as with the disabled or chronically ill beneficiary, you give up nothing by naming a STAT rather than a conduit trust.
• The above conclusions are based on the pre-Secure Act Treasury regulations. It is possible that the IRS will loosen up the rules when it finally gets around to issuing Secure regulations. (I'm not holding my breath.)

Finally, what about the “D” category? “D” is a trust that does not qualify as either a conduit trust or a STAT. If the client is adamant about including trust terms that “violate” the IRS’ see-through trust rules (for example, by including nonindividual beneficiaries), the minimum distribution result will be “nondesignated beneficiary” status. The participant’s own estate is also a “D” beneficiary. Regardless of whether the individual beneficiary of the trust (or estate) is an “eligible designated beneficiary” or even a “plain old designated beneficiary,” the payout period for benefits paid to this trust (or the client’s estate) will be the five-year rule if the participant died before his required beginning date, otherwise what would have been the deceased IRA owner’s remaining life expectancy.

Where to read more: The IRS' "minimum distribution trust rules" are explained in detail in Chapter 6 of the author's book Life and Death Planning for Retirement Benefits (8th ed. 2019; Ataxplan Publications).

Natalie Choate is a lawyer in Wellesley, Massachusetts, who concentrates in estate planning for retirement benefits. The 2019 edition of Choate's best-selling book, Life and Death Planning for Retirement Benefits, is available through her website, www.ataxplan.com, where you can also see her speaking schedule and submit questions for this column. The views expressed in this article do not necessarily reflect the views of Morningstar.