IRA Trusts Could Soon Become an Estate Planning Nightmare
If Congress decides to eliminate the stretch IRA, estate planning could become a lot more complicated, as we discuss below. This is unfortunately a real possibility, as the House recently passed the “Secure Act,” which eliminates the stretch IRA and replaces it with a 10-year payout for most non-spouse beneficiaries, including trusts.
Stretch IRAs essentially allow someone to stretch out the required minimum distributions (RMDs) from an inherited IRA over time. Because Congress has long been against retirement accounts being used for estate planning, both the House and Senate have been mulling over their own bills to reduce the payout for beneficiaries to only five years for some time now; with the House taking action recently to move this forward. This would have a number of implications on those who have already named a trust as their IRA or plan beneficiary because their plan will no longer help them accomplish the estate planning objectives that they had in mind.
Accumulation (or Discretionary) Trusts and Conduit Trusts
In order to understand more about stretch IRAs, it is important to know more about what are known as accumulation (or discretionary) trusts and conduit trusts. With accumulation trusts, trustees can decide whether to pay out RMDs to the trust beneficiaries or retain those funds and protect them over time. Conversely, conduit trust RMDs are automatically paid from the inherited IRA to the trust and then from the trust of the beneficiaries each year. This means that no RMDs remain in the trust and beneficiaries pay taxes on the RMDs at their own rates.
Where this becomes complicated in terms of the proposed legislation is where payout is currently limited to, for example, 10 years after death. This creates a problem if, for example, Congress decides to limit pay out to five years. With a conduit trust, for example, there would be no RMDs and at the end of the 10 years, the entire inherited IRA would be paid out, leaving no funds protected in the trust, and the beneficiaries with a huge tax bill. With an accumulation trust, while funds could remain in the trust (and stay protected), this would also result in a huge tax bill because the funds that were made in the trust would be taxed at trust tax rates. In other words, those with large IRAs would be subject to tax acceleration rates and the long-term benefits of the trust would essentially be lost.
Who The Proposed Legislation Will Affect, And How
Those most affected if the Senate passes a bill as well will be those with the largest IRAs, as they are most likely to name a trust as the beneficiary in order to control distributions over time (and try to protect the IRA for decades). Therefore, if these proposals become law, IRA trust planning will have to be completely revisited, and everyone who has a named trust as their IRA beneficiary will need to review those plans and look for alternatives.
One alternative option will likely be life insurance becoming a more reliable estate planning tool because life insurance proceeds can be left to a trust to gain that protection and stimulate the stretch IRA. IRAs, conversely, would be better off being withdrawn now and then having that balance invested in life insurance because life insurance is a more flexible asset to leave in the trust.
Discuss with an Experienced Estate Planning Attorney
Make sure that if this law passes, and you have a large IRA, you discuss all of these details with your estate planning attorney, as large IRAs will no longer be the best estate planning vehicle. If you live in Florida, contact our experienced Orlando estate planning attorneys at Gierach and Gierach, P.A. today for a free consultation to discuss.