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Understanding the SECURE Act’s Impact on IRAs Left to Trusts

In 2019, the SECURE Act introduced significant changes to retirement accounts, and in 2022, the IRS provided proposed regulations that surprised many financial professionals. Now, in 2024, the IRS has finalized these rules, and they have a big impact on how IRAs left to trusts are managed. These regulations clarify some aspects but also introduce complexity, which could lead to potential tax issues.

Why Leave an IRA to a Trust?

People often name a trust as the beneficiary of an IRA to:

  • Protect assets from creditors (especially after the 2014 Supreme Court decision in Clark v. Rameker, which removed some creditor protections for inherited IRAs).
  • Control how funds are distributed to beneficiaries, especially if they are minors or have spending issues.
  • Provide financial support for special needs beneficiaries while preserving government benefits.

Before the SECURE Act, trusts could “stretch” IRA distributions over the life expectancy of the beneficiary, helping to minimize tax burdens. Now, however, the rules have changed significantly.

Key Steps in Determining Trust Distribution Rules

The final regulations introduce a multi-step process for determining how an IRA left to a trust will be distributed:

Step 1: Is the Trust a “See-Through Trust”?

A see-through trust allows the IRS to recognize the beneficiaries of the trust as the actual IRA beneficiaries. To qualify:

  1. The trust must be legally valid.
  2. It must be irrevocable upon the IRA owner’s death.
  3. The beneficiaries must be identifiable.
  4. The trustee must provide proper documentation to the IRA custodian.

If a trust does not meet these conditions, it is treated as a non-designated beneficiary, meaning the IRA must be liquidated within five years (if the owner died before their required beginning date) or follow the owner’s existing withdrawal schedule.

Sub-Trusts

If a trust splits into sub-trusts after the IRA owner’s death, each sub-trust is analyzed separately to determine distribution rules.

Step 2: Conduit vs. Discretionary Trusts

  • Conduit Trusts: IRA withdrawals must immediately be paid out to the trust beneficiaries. Only the primary beneficiaries are considered when determining the payout period.
  • Discretionary Trusts (also called accumulation trusts): IRA distributions can remain in the trust instead of being immediately distributed. However, all potential beneficiaries must be considered when determining payout rules.

Examples:

  • A conduit trust with a spouse as the primary beneficiary can stretch distributions over the spouse’s life.
  • A discretionary trust with multiple beneficiaries may be forced into a 10-year distribution period.

Step 3: Who Are the Trust’s Beneficiaries?

Beneficiaries fall into three categories:

  1. Eligible Designated Beneficiaries (EDBs) – These include surviving spouses, minor children (until age 21), disabled individuals, and those within 10 years of the original IRA owner’s age. They can still stretch distributions over their life expectancy.
  2. Non-Eligible Designated Beneficiaries (NEDBs) – Most adult children and other beneficiaries fall into this group. They must follow the 10-year rule, meaning the entire IRA must be withdrawn within 10 years.
  3. Non-Designated Beneficiaries – Estates, charities, and non-qualifying trusts fall into this category. These generally follow the 5-year or “at least as rapidly” rule.

Step 4: Determining the Distribution Options

The available distribution options depend on the beneficiary category and whether the IRA owner passed before or after their Required Beginning Date (RBD).

Scenarios:

  • If the IRA owner passed before their RBD:
    • EDBs can stretch distributions or choose a 10-year deferral.
    • NEDBs must withdraw the full balance within 10 years.
    • Non-designated beneficiaries must follow the 5-year rule.
  • If the IRA owner passed after their RBD:
    • EDBs can stretch payments, but they must take Required Minimum Distributions (RMDs).
    • NEDBs still follow the 10-year rule but must take RMDs annually.
    • Non-designated beneficiaries must take RMDs based on the deceased owner’s life expectancy.

Special Rule: Applicable Multi-Beneficiary Trusts (AMBTs)

A new category called AMBTs allows certain trusts benefiting disabled or chronically ill individuals to qualify for more favorable distribution options. These trusts are treated as conduit trusts, meaning the disabled beneficiary can stretch payments over their lifetime.

Planning Considerations

  • If you want to preserve the stretch option, ensure the trust qualifies as a see-through trust and that all considered beneficiaries are EDBs.
  • If a trust includes NEDBs, it will likely be subject to the 10-year distribution rule instead of a lifetime stretch.
  • Consider Roth IRAs, as they are not subject to lifetime RMDs, which can provide more flexibility under the 10-year rule.

LPL Financial, Daniel Romero and their respective representatives do not provide tax, accounting, or legal advice. Any tax statements contained herein were not intended or written to be used and cannot be used for the purpose of avoiding U.S. federal, state, or local penalties. Tax laws are complicated and subject to change. Tax results may depend on each taxpayer’s individual set of facts and circumstances. Clients should rely on their own independent advisors as to any tax, accounting, or legal statements made herein.

 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.