SECURE Act Planning Strategies: Optimizing Beneficiary Designations

SECURE Act Planning Strategies

The SECURE Act has ushered in significant changes in estate planning, particularly in the realm of beneficiary designations. The use of specific trusts as beneficiaries, once a common practice, may no longer be as effective and could even lead to substantial tax liabilities for beneficiaries. To navigate these changes, it is crucial to review and update your beneficiary designations on IRA accounts.

Under the SECURE Act, trusts must qualify as “See-Through Trusts” to receive either the ten-year or stretch payout for eligible designated beneficiaries. All other trusts are subject to the accelerated five-year payout, potentially exposing them to trust tax rates, which can reach the maximum 37% federal bracket with just $14,450 in income in 2023.

There are two main categories of “See-Through” trusts: conduit trusts and discretionary trusts, also known as accumulation trusts.

Conduit Trusts:

These trusts serve as intermediaries between the IRA and the beneficiary. They allow funds to be paid directly to the beneficiary, ensuring taxation at the individual’s income tax rate. However, if the trust only pays out Required Minimum Distributions (RMDs), a beneficiary subject to the 10-year rule may not access the majority of funds until year 10, when they must withdraw the entire sum unless additional provisions are added.

Example: George’s IRA account of $1 million names a conduit trust with his daughter Georgina as the trust beneficiary. Georgina, subject to the 10-year rule, cannot access funds other than RMDs until year 10, leading to a substantial tax burden when she withdraws the entire amount.

Discretionary Trusts:

These trusts grant the trustee the authority to distribute funds to beneficiaries or retain them within the trust. Funds held in the trust are subject to trust tax rates, which can reach the 37% bracket after just $14,450 in income in 2023. For a beneficiary subject to the 10-year rule, any remaining funds after year 10 must be withdrawn and either distributed directly (at the beneficiary’s tax rate) or placed in the trust (at trust tax rates).

Example: Sam’s $1 million IRA designates a discretionary trust with her daughter Janet as the trust beneficiary. In the 10th year following Sam’s death, the inherited IRA holds $1.5 million, subjecting it to trust tax rates if funds are paid into the trust.

Those who have not named a beneficiary or have named their estate as the beneficiary should also revisit and update their beneficiary designations. In such cases, the IRA becomes subject to a 5-year rule, potentially magnifying the tax impact of accelerated distributions.

Example: Michael has a $1 million IRA with no designated beneficiary. His son, Michael Jr, inherits the account as part of his estate, requiring him to withdraw the entire amount in just 5 years. This acceleration affects his tax bracket, even with a tax-conscious approach.

Adding contingent beneficiaries is a wise move to prevent funds from becoming subject to the 5-year rule in case something happens to your primary beneficiary. It also grants flexibility to the primary beneficiary to disclaim the inherited funds if they are not needed.

Regularly reviewing your estate plan in response to life events or legislative changes is a prudent practice. The SECURE Act and the Tax Cuts and Jobs Act have transformed the estate planning landscape. If you have not yet assessed the impact of these changes on your existing documents or designations, consult with your financial advisor and estate planning attorney to determine if adjustments are needed.

Disclosure: The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Michael Dunham and not necessarily those of Raymond James.

Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional.

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