Recent changes to US tax laws should prompt people to rethink whether they should designate trusts as their beneficiaries, due to changes in how retirement accounts are treated, a law firm says.

In the past, a beneficiary who inherited a retirement account could defer income taxes by taking distributions from the account as slowly as possible over the beneficiary’s life expectancy. But this situation is changing, Caplin & Drysdale Attorneys said in a recent note.

In the past, specially designed trusts, often called “see-through trusts” or “conduit trusts,” allowed certain trusts named as beneficiaries to receive the same preferential treatment. These inherited retirement accounts are often referred to as “Stretch IRAs” since the payments can be stretched over the beneficiary’s life expectancy.  

Some clients have used such tax planning to incorporate “see-through trusts” into their estate plans.

However, Congress has enacted a new law, called the SECURE Act, which affects this tax planning, the law firm continued. Effective for accounts of individuals who die after December 31, 2019, most beneficiaries will be able to defer distributions for no more than ten years after the participant’s death. The new rules apply to Roth IRAs as well as traditional IRAs and other similar retirement plan accounts.

Prior law defined two categories of beneficiaries, those who were “designated beneficiaries” and those who were not. The new law preserves those classifications, changes the treatment of designated beneficiaries, and adds one additional category, “eligible designated beneficiaries.” 

In the past, the law distinguished between the treatment of inherited retirement accounts, depending on whether the participant died before his or her required beginning date for taking distributions from retirement accounts or after.  The new law does away with that distinction.

The new regime:
Under the new law, eligible designated beneficiaries are the only beneficiaries who can stretch out IRA payments for more than 10 years. The only eligible designated beneficiaries are the surviving spouse of the participant, a minor child of the participant , a disabled individual, a chronically ill individual, or an individual who is not more than 10 years younger than the participant.  A minor child must take distributions within a 10-year period beginning at his or her age of majority.  Other eligible designated beneficiaries, including a surviving spouse, may take distributions over their life expectancies. 

The new law does not change the definition of a designated beneficiary. Thus, all individuals and “see-through” trusts remain designated beneficiaries. However, under the new law, all designated beneficiaries must take the funds out of the retirement account within ten years after the participant’s death. 

Caplin & Drysdale notes that there are two types of “see-through trusts” that qualify as designated beneficiaries. The first is a “conduit trust” that passes out all of the distributions it receives from the retirement account to the beneficiaries. Certain “accumulation trusts” can also qualify. However, under prior law, practitioners generally avoided using accumulation trusts because the rules regarding the computation of the relevant beneficiaries’ life expectancies were unclear, it said.  

Now, however, the beneficiaries’ life expectancies will no longer be a factor in determining the payout period. Moreover, depending on how a “conduit trust” provision is drafted, it may not work under the new law, meaning that it may not be possible to delay payments for the maximum ten years.