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IRA trusts could become an estate planning disaster

If Congress eliminates the stretch IRA, advisers will have to rethink IRA trust planning

Jun 11, 2019 @ 11:22 am

By Ed Slott

The new SECURE Act that was passed overwhelmingly by the House in a 417-3 vote on May 23 contains a provision to eliminate the stretch IRA and replace it with a 10-year payout for most non-spouse beneficiaries, including trusts.

Stretch IRAs allow designated beneficiaries to extend distributions from inherited individual retirement accounts over their lifetimes. For example, a 25-year old beneficiary could stretch required minimum distributions from their inherited IRA for over 58 years.

Congress has long believed retirement accounts are for retirement and should not be employed as an estate planning vehicle. The Senate is currently mulling its own bill which might reduce the payout for beneficiaries to only five years, with its own exceptions.

What does this mean for those who have named a trust as their IRA or plan beneficiary? Disaster.

Their plan will no longer work as far as accomplishing the estate planning objectives of controlling the funds for beneficiaries and qualifying for the stretch IRA.

Those with the largest IRAs will be the most affected since they are more likely to name a trust as their IRA beneficiary in order to control distributions to their beneficiaries and preserve the IRA for decades after death.

(More: Ed Slott: How tax reform impacted popular IRA strategies)

There are two types of IRA trusts. If any version of the proposals to eliminate stretch IRAs becomes law — which now seems like just a matter of time — IRA trust planning will have to be revisited and maybe even scrapped for an alternative plan.

The two IRA trusts are commonly known as conduit trusts and accumulation (or discretionary) trusts. Under current rules, if the IRA trust qualifies as a see-through trust, the trust beneficiaries can be treated as if they were named directly and the stretch payout will be permitted.

With a conduit trust, RMDs are paid from the inherited IRA to the trust and then paid from the trust to the trust beneficiaries each year. No RMDs remain in the trust. The beneficiaries pay tax on the RMDs at their own personal tax rates.

With an accumulation trust, the trustee has discretion on whether to pay out the RMDs to the trust beneficiaries or retain those funds in the trust to protect and preserve the funds. If the funds are retained in the trust, they will be taxable to the trust at the high trust tax rates (except for a Roth IRA, where there is no tax on distributions from the inherited Roth IRA to the trust).

It's going to be a problem if the payout is limited to, say, 10 years after death. With the conduit trust, there would be no RMDs, except that at the end of the 10 years the entire balance in the inherited IRA would be paid out to the beneficiaries, leaving no funds protected in the trust and beneficiaries with a mega tax bill.

If an accumulation trust is the beneficiary, then again all of the inherited IRA funds would have to be paid to the trust by the end of the 10 years. Since this is an accumulation trust, the trustee does not have to pay out all of the funds to the trust beneficiaries, so the funds could still remain in the trust and be protected, but at what cost? All funds remaining in the trust would be taxed at trust tax rates.

Remember that this impact will be the greatest for the largest IRAs and could subject them to tax acceleration at high rates; in some cases the long-term benefits of the trust protection would be lost.

(More: 100% required minimum distributions)

Every person who has named a trust as their IRA beneficiary will need to review those plans and likely look for alternative planning solutions.

Life insurance will emerge as a better, more tax-efficient planning vehicle, in which the life insurance proceeds can be left to a trust to gain the trust protection and simulate a stretch IRA.

IRAs would be better off being withdrawn now at today's low tax rates; the balance after tax can be invested in life insurance. Life insurance is a more flexible asset to leave to a trust. In addition, with life insurance the planning will be simpler since there will be no RMDs, no complicated tax rules and best of all — no tax!

Large IRAs will no longer be a valuable estate planning vehicle — which is exactly what Congress wants. But if enacted, these proposals will simply push advisers to do better and more tax-efficient planning for large IRAs.

(More: Ed Slott: Advisers should be doing Roth conversion projections for this year)

For more information on Ed Slott, Ed Slott's 2-Day IRA Workshop and Ed Slott's Elite IRA Advisor Group, please visit www.IRAhelp.com.

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