The Setting Every Community Up for Retirement Enhancement (SECURE) Act was enacted on December 20, 2019 and is now the law. While its primary goal was to encourage people to save more for retirement, it also attempts to cover the tax shortfall that will be caused by the Act’s taxpayer-friendly provisions, and that is where the problems arise. The SECURE Act actually increases the taxation of assets in a retirement savings account after the death of the original account owner (the “participant”). These provisions, which were designed to put more money back in government coffers, were primarily accomplished by changing the rules governing Required Minimum Distributions (“RMDs”). RMD rules are complex, but they are important to understand for purposes of estate planning. In fact, RMD rule changes made by the SECURE Act may require changing your estate planning documents to ensure that your estate plan continues to work as you intend.

The Coronavirus Aid, Relief, and Economic Security Act or “CARES Act” was enacted by Congress and signed into law on March 27, 2020. Because the CARES Act affects retirement plans as well, some professionals are referring to the CARES Act as SECURE Act No. 2. We have added Question 13 to summarize the relevant changes made by the CARES Act.

In order to help make these rules and their impact on your estate plan easier to understand, we are providing the following Q&A. Of course, we are here for you when you are ready to discuss your particular situation.

Table of Contents

Question 1: What are the RMD rules and, in a very general way, what did the SECURE Act do to them? 
Question 2: What are the major changes to the RMD rules? 
Question 3: Who qualifies as an EDB? 
Question 4: If the participant’s child is the direct beneficiary of the participant’s retirement plan account, is the child allowed to have the entire balance of the retirement plan account distributed to himself or herself once he or she reaches the age of majority (age 18 in Georgia)? 
Question 5: What is the age of majority, and what is its effect? 
Question 6: What if the named young beneficiary is not the participant’s legal child, but rather a grandchild, step-child, niece, or nephew? 
Question 7: Do you have to name your desired beneficiaries directly, or can you name a trust to benefit your desired beneficiaries? 
Question 8: Why would you want to name a trust as the retirement plan beneficiary rather than your loved one directly? 
Question 9: What are the three (3) types of trusts for purposes of the RMD rules? 
Question 10: If your current estate planning documents contemplate passing your retirement savings accounts to “conduit trusts,” should you keep it this way or do you need to make a change? 
Question 11: Based on all of the available beneficiary designation options, which one should you use? 
Question 12: Can you take any steps to reduce the negative tax effects from the changes in the RMD rules? 
Question 13: How did the CARES Act affect the RMD rules and other ways to benefit from a retirement plan? 
Final Question: What should you do now? 

Question 1: What are the RMD rules and, in a very general way, what did the SECURE Act do to them?

The SECURE Act changed the RMD rules, which mandate how fast IRA and Qualified Retirement Plan (“retirement plan”) assets must be distributed to the owner/participant (“participant”), or to the beneficiaries after the participant’s death. This is important because retirement plan assets are not taxed until they are distributed. If the participant or beneficiary fails to distribute the entire RMD for any given year, he or she will be subject to an annual 50% penalty tax on the shortfall until corrected.1 The SECURE Act generally requires a faster payout of a participant’s retirement plan assets to the named beneficiaries after the participant’s death.

From a tax perspective, the shorter RMD period will likely cause income tax to be paid sooner and at likely higher rates. From a non-tax perspective, the RMD rule changes have a much bigger impact when a trust is the most appropriate beneficiary of a retirement plan account.

Question 2: What are the major changes to the RMD rules?

The SECURE Act changed the rules for distributions to designated beneficiaries (“DBs”). Under the old rules, payout of the retirement plan assets passing to a DB could be stretched out over a period of years equal to the beneficiary’s life expectancy (“LE”), beginning in the year after the participant’s death. This period of time was used to determine the annual RMDs that the DB must take. However, after the SECURE Act went into effect on January 1, 2020, full payout of all assets that remain in a retirement plan must be distributed completely to the DBs no later than December 31st of the calendar year that contains the 10th anniversary of the participant’s death (“10-year cliff rule”). However, a special category of eligible designated beneficiary (“EDB”) is generally allowed to use the old LE rule (i.e., receive RMDs that are based on the EDB’s own life expectancy).2

While the SECURE Act generally begins to apply on January 1, 2020, the SECURE Act has a delayed effective date of January 1, 2022 for certain types of retirement plans. The most important type of retirement plans with this delayed effective date are Governmental plans. While not totally clear, governmental plans likely refer to the types of plans used by Federal, state or local government authorities, including 403(b) and 457 Plans. However, and while not clear, the delayed effective date may be limited not only to the type of plan but rather to the sponsoring employer being a federal, state, or local governmental entity.

Where the participant died before the SECURE Act’s effective date, the DB continues to utilize RMDs based on the DB’s LE, but upon the DB’s death, the RMDs switch to the 10-year cliff rule. Where the participant died after the SECURE Act’s effective date and the beneficiary qualifies as an EDB to use RMDs based on their LE, then upon the EDB’s death (or when participant’s minor child attains age of majority), you switch to the 10-year cliff rule.

Question 3: Who qualifies as an EDB?

As discussed above, EDBs utilize their LE for purposes of the RMD rules. EDBs include: (i) the participant’s spouse; (ii) someone who is not more than 10 years younger than the participant; (iii) an individual who is qualified as disabled or chronically ill; and (iv) to a limited extent, the participant’s children. The RMD based on the child’s LE only applies to a child of the participant until the child attains the age of majority, after which the child is subject to the new 10-year cliff rule.

Following are some important points to understand regarding EDBs:

A. Someone not more than 10 years younger than the participant. Such an individual could be older than,3 about the same age as or up to 10 years younger than the participant. This status may apply, for example, to parents, non-married life partners, siblings, cousins and friends.

B. An individual who is qualified as disabled or chronically ill. This status may be difficult for a beneficiary to attain, unless the beneficiary is already qualified as disabled or chronically ill on the date of the participant’s death for other purposes, such as receiving social security disability benefits (“SSDI”), Medicaid, or, possibly, private disability or long-term care insurance benefits. We are hopeful that the IRS will liberalize these rules, but, as of now, fairly strict requirements must be met as of as of the participant’s date of death.

C. Participant’s child. First, this EDB status does not simply apply to any young beneficiary. Rather, this status is limited to the participant’s natural or adopted children, and does not to any other of the participant’s descendants, such as grandchildren. Further, step-children do not qualify as EDBs. Second, the definition of age of majority is unclear. At this point, we believe it means the state law age of majority, which in GA is age 18, but it can be extended up until age 26 based on educational status. However, until the IRS issues Regulations, it is unclear what is meant by necessary educational status to extend the age of majority for this purpose.

Question 4: If the participant’s child is the direct beneficiary of the participant’s retirement plan account, is the child allowed to have the entire balance of the retirement plan account distributed to himself or herself once he or she reaches the age of majority (age 18 in Georgia)?

Yes! First, no distributions from a retirement plan account can be made to anyone other than the participant during the participant’s lifetime. However, after the participant’s death, the RMD rules look to the beneficiary of the account to determine how fast the remaining account assets must be paid out. If the participant’s child is the successor beneficiary (either because the participant named the child as the beneficiary on the beneficiary designation form, or because the participant failed to name a beneficiary and the plan terms provide that the participant’s children are automatically the beneficiaries in the absence of a named beneficiary) then the child is either a normal DB (if he or she is over the age of majority at the time of the participant’s death), or an EDB (if he or she is under the age of majority at that time). If the child is under the age of majority, then the RMDs are based on the child’s LE, but only until the child attains the age of majority, at which point the RMDs change to being based on the new 10-year cliff rule. If the participant’s child has already attained the age of majority when the participant dies, then the RMDs are based on the new 10-year cliff rule.

The bigger issue, however, is who controls the distributions from the retirement account. The RMD rules do not prohibit larger distributions; they only mandate the minimum that needs to be distributed. State laws generally provide that a minor child does not have the legal right to control assets before the state law age of majority. For example, when the minor child receives a check as a birthday present, the check is deposited into a custodial account on the child’s behalf, so the custodian (normally the parent) can control the account funds until the child attains the age of majority. However, when the child attains the age of majority, the child has total control over his or her assets. As a result, the day the child attains the age of majority (age 18 in GA), the child can take a full distribution of the entire retirement plan account.

Question 5: What is the age of majority, and what is its effect?

There may be more than one age of majority, depending on the purpose. The law of the state where the child is domiciled (i.e. where the child permanently resides) determines the state law age of majority. In Georgia, a child reaches the state law age of majority and is considered an adult for legal purposes once the child reaches 18 years of age. However, a custodial account can be held by the custodian for the child’s benefit until the child reaches age 21. For purposes of the RMD rules, the age of majority would initially be determined by the applicable state law, but may then be extended up to age 26, depending on the child’s educational status. At this point, the law is unclear as to what educational status is necessary to extend the age of majority.

For example, if the participant dies when his or her child is under the age of majority, the child’s RMDs are required to be made annually based on the child’s LE until the child attains age 18, at which point the RMDs will switch to the new 10-year cliff rule, so that all retirement plan assets must be fully distributed by December 31st of the year the child attains age 28 (assuming state law age of majority of 18 and no educational status extension applies). Of course, the child will have access to the full retirement plan account balance at age 18 if the child is named directly as the beneficiary.

Question 6: What if the named young beneficiary is not the participant’s legal child, but rather a grandchild, step-child, niece, or nephew?

In this case, the young beneficiary is a normal DB who will need to comply with the new 10-year cliff rule. All of the assets in the retirement plan must be distributed to the DB within 10 years following the date of death of the plan participant, regardless of whether the DB was of minority age or majority age when the participant died. While the participant is a minor under the state law of the DB’s state of domicile, those distributions could be held in a custodial account and controlled by the custodian (usually a parent), but once the DB reaches majority age, he or she would have control over the assets in the custodial account.

For example, if the DB is only 4 years old when the participant dies, then all of the assets in the retirement account would still need to be distributed by December 31 of the calendar year that contains the 10th anniversary of the participant’s death, at which time the DB in this example will still be a minor.

Let’s look at another example, where the DB is 16 when the participant dies, and the applicable age of majority is 18. In this example, if there are still assets remaining in the retirement account when the DB turns 18 (remember, RMDs mandate minimum distributions, but not maximum distributions), then the DB could opt to take a full distribution of the remaining assets immediately. As long as all retirement plan assets are fully distributed before December 31st of the calendar year that contains the 10th anniversary of the participant’s death, the DB would not have any RMD related penalty tax.

Question 7: Do you have to name your desired beneficiaries directly, or can you name a trust to benefit your desired beneficiaries?

You can absolutely name a trust for your loved one’s benefit as the retirement plan beneficiary. The bottom line in dealing with the SECURE Act is to first determine if the retirement plan beneficiary should be your loved one directly or a trust that is held for your loved one’s benefit. If you decide to have a trust that is held for your loved one’s benefit be the beneficiary of the retirement plan, then you must decide which of three (3) possible trust types should be used (discussed in the answer to Question 9, below.)

Question 8: Why would you want to name a trust as the retirement plan beneficiary rather than your loved one directly?

The primary purposes of naming a trust as the beneficiary are the non-tax benefits of asset protection and control. As long as the retirement plan or its assets remain in trust, these assets remain protected from the loved one’s spouse in a divorce, from holders of his or her personal guarantees, from his or her judgement creditors, from bankruptcy proceedings, and from predators. In addition, the selected Trustee will control the trust’s assets as directed by the trust’s terms. So, for example, naming a trust that benefits your child as the retirement plan beneficiary, rather than naming your child directly, can ensure that the child does not get control over the retirement plan at a young age.

Question 9: What are the three (3) types of trusts for purposes of the RMD rules?

The three (3) types of trusts include: (i) conduit trusts; (ii) see-through accumulation trusts; and (iii) non-DB trusts.

The SECURE Act only changed the RMD period for designated beneficiaries (“DBs”) and a new special class of Eligible Designated Beneficiaries (“EDBs”). The SECURE Act did not change the actual definition of a DB. DBs include only individuals and two types of “see-through” trusts: conduit trusts and see-through accumulation trusts. Basically, the IRS rules look through a trust to its possible beneficiaries. For a trust to qualify as a DB, all of its present and future possible beneficiaries (other than those that are considered to be “mere potential successor” beneficiaries) must be individuals, and you need to be able to identify the individual in this group with the shortest LE at the participant’s death.4 Before the SECURE Act, the LE for RMD purposes was based on this shortest LE. However, after the SECURE Act, you just need to be able to satisfy these requirements.5

The conduit trust requires that all of the distributions made from the retirement plan to the trust must be immediately paid out to the selected conduit beneficiary. In this case, the conduit beneficiary is deemed to be the only beneficiary of the trust, and all other possible trust beneficiaries are ignored as “mere potential successor” beneficiaries. If the conduit beneficiary is also an EDB, the conduit beneficiary’s LE will be used for RMD purposes. If the conduit beneficiary is not also an EDB, then the 10-year cliff rule applies. As a result, if the 10-year cliff rule applies for RMD purposes, then the asset protection and control benefits of the trust will be lost with regard to the retirement plan assets within 10 years.

It is important when structuring a conduit trust to give the Trustee power to make distributions in addition to the RMD amount, consistent with the Trustee’s distribution discretion and/or to provide tax planning benefits. If this is not done, then no retirement plan distributions will be made under the 10-year cliff rule until the 10th year, at which point, all of the retirement plan balance must be distributed. This may end up being an unintended and very poor result.

The see-through accumulation trust is not required to immediately distribute all of the distributions made from the retirement plan to the trust. In other words, while the RMD rules determine how fast the assets in a retirement plan account must be distributed to the trust, it is the Trustee that decides on the timing of any trust distributions to the trust beneficiaries. Whereas the conduit trust is a safe harbor see-through trust option under the regulations, no such safe harbor rules apply to see-through accumulation trusts. Based on what little the IRS has provided in its regulations and in many Private Letter Rulings, we understand that the trust’s terms must be limited as discussed in the following paragraph. You should note that these rules are fairly nonsensical, but they exist, so these are the rules we live with until they are changed. In addition, because of these requirements, retirement assets are normally placed in separate trust shares to limit the effect on other non-retirement plan assets.

A see-through accumulation trust must limit its possible beneficiaries, both as described in the trust’s terms and as could be added with a power of appointment in the future.6 Specifically, it must prohibit the following from ever benefitting from the retirement plan assets: (i) any non-individual beneficiary (i.e., no charities and no general powers of appointment for flexibility and tax planning purposes); and (ii) any person who is older than the oldest living potential trust beneficiary on the date of the participant’s death (i.e., reduces flexibility of limited powers of appointment and it may turn out that one or more older heirs (via the contingent beneficiary provision) will be unable to benefit in the future if all of the descendants are deceased but assets remain.

The non-DB trust is a trust that does not qualify as either a conduit or a see-through accumulation trust. In other words, this type of trust does not jump through any IRS hoops to qualify as a DB. In this case, the RMD depends on the participant’s age when he or she died. If the participant died before the Required Beginning Date (“RBD”), the RMD is based on the 5-year cliff rule (i.e., all assets of the retirement plan must be distributed by December 31st of the calendar year that contains the 5th anniversary of the participant’s death). However, if the participant died on or after the RDB, the RMD is based on the participant’s ghost LE (i.e., the participant’s LE as if he or she were still living). The only change to non-DB trusts under the SECURE Act was to change how you calculate the RBD. The RBD has changed from April 1st of the year after the participant turns age 70 1/2 to April 1st of the year after the participant turns age 72.

Following are some important points to understand regarding non-DB trusts:

A. Ghost LE. It should be noted that the ghost LE (the deceased participant’s LE determined as if still living) based on the IRS’ applicable LE table is more than 10 years until about age 80, and it is about 5 years at age 91.

B. Roth IRAs. Since Roth IRAs do not have RMDs during the participant’s life, no RDB exists and therefore it may be that Roth IRAs can only use the 5-year cliff rule for RMD purposes.

C. Qualified Retirement Plan (“QP”) account rollover to an Inherited IRA account. QPs normally have more limited distribution options than IRAs. Whereas an employer who is sponsoring a QP will likely not want responsibility for dealing with a retirement plan account for a deceased employee’s family member, IRA custodians/trustees, such as Charles Schwab and Fidelity Investments, are in this business and normally provide all the legally possible distribution options. As a result, while the law may provide RMD rules based on annual minimum payments over a LE, a 10-year cliff rule or a 5-year cliff rule, a QP may limit distributions to as little as a full payout in one to three years. To deal with this issue, Federal law was changed to provide that after a participant’s death, a QP beneficiary can rollover the QP account to an Inherited IRA. The caveat is that this rollover option only applies to DBs. As a result, a participant with a significant QP account balance may not want to utilize a non-DB trust because of the risk of a total loss of otherwise available income tax deferral.

Question 10: If your current estate planning documents contemplate passing your retirement savings accounts to “conduit trusts,” should you keep it this way or do you need to make a change?

Needing to make a change or not will depend on the weighing of the pros and cons of the various options in your particular situation.

Before the SECURE Act, most trusts were structured as conduit trusts, as that type of trust normally had the best mix of pros and cons. All retirement plan distributions to the trust had to be immediately distributed to the conduit beneficiary, such as a child, but the amount would normally not be significant since the RMDs were based on the beneficiary’s LE. The younger the conduit beneficiary, the smaller the RMDs. The conduit trust’s asset protection and control benefits could also operate on a long-term basis.

However, after the SECURE Act, conduit trusts may no longer make a lot of sense if the asset protection and control benefits of trusts are desired on a long-term basis since all the retirement plan assets will generally need to be fully distributed to the conduit beneficiary within a 10-year period. Conduit trusts may still make sense for the following loved ones: (i) the participant’s spouse, but with the same caveats as before the SECURE Act, only if the participant is willing to both give up potentially significant income tax deferral and be willing to have retirement plan distributions forced out to the spouse over the spouse’s LE; (ii) someone who is not more than 10 years younger than the participant, if the participant is willing to force distributions out to this individual over the individual’s LE; and (iii) other individuals if determine the pros outweigh the con of forcing retirement plan distributions out to the beneficiary within a 10 year period. This con may not be so bad where the full inheritance is intended to pass outright to the children (or other loved ones) upon attaining ages of maturity, such as age 25 or 30, or if the amount of retirement plan assets is not significant in either amount or in relation to the overall inheritance and the individual does not have a significant need of protection for these assets from unwanted outsiders, including a spouse, personal guarantees, judgement creditors, bankruptcy or predators.

See Question 11 below for further information on how to choose the best option in a particular situation.

Question 11: Based on all of the available beneficiary designation options, which one should you use?

The available beneficiary options include: (i) designating an individual beneficiary directly; (ii) designating a charity directly; (iii) designating an estate directly; (iv) using a conduit trust; (v) using a see-through accumulation trust; (vi) using a non-DB trust; and (vii) using a charitable structure, including a charitable remainder trust (“CRT”), a charitable gift annuity (“CGA”) or a charitable pooled income fund (“PIF”). Below is a discussion of each of these options.