SECURE Act changes: Protect your retirement legacy for minor beneficiaries

The SECURE Act introduced the concept of eligible designated beneficiaries (EDBs), which includes minor children of the account owner. According to the regulations, a minor child is considered an EDB until they reach the age of 21. It's important to note that this classification only applies to the account owner's children, not grandchildren, stepchildren or other young individuals.

For adopted children or those conceived through reproductive technology, their status as an EDB depends on state law and how they're treated in relation to the account owner. This distinction is crucial because it affects how required minimum distributions (RMDs) are calculated and distributed.

For minor children who qualify as eligible designated beneficiaries, required minimum distributions are calculated based on the child's life expectancy using the Single Life Table, with one year subtracted each subsequent year. This calculation method continues until the child reaches age 21, at which point the 10-year rule comes into effect.

Under the 10-year rule, RMDs based on the child's life expectancy continue until they reach age 31. By December 31 of the year the child turns 31, all assets from the inherited IRA must be withdrawn. This approach, which could be called the “life expectancy plus 10-year rule," provides a longer distribution period compared to non-EDB beneficiaries.

When planning to leave retirement assets to minor children, several options are available. An experienced attorney can help individuals and families determine which options are best for their estate planning objectives. Some options to consider include:

• Outright beneficiary designation. While possible, this is generally not advised for children under 18 as it would require court intervention to appoint a guardian or conservator.
• Uniform Transfers to Minors Act (UTMA) custodianship. This option eliminates the need for court proceedings. A beneficiary designation might read: "If (child’s name) has not reached the age of majority under (state) law at the time of my death, I name (custodian's name) as custodian for (child’s name) under the Uniform Transfers to Minors Act of (state) as beneficiary of my IRA."
• Conduit trust. This trust structure passes all RMDs directly to the beneficiary. It works similarly to naming the child as a direct beneficiary or using a UTMA custodianship for tax purposes.
• Accumulation trust. For significant retirement accounts, this option provides more control and flexibility in the distribution of assets.

When considering estate planning options for young beneficiaries under the SECURE Act, conduit trusts present both advantages and disadvantages that merit careful consideration.

One of the primary benefits of a conduit trust is the professional management it provides for the inherited IRA. This management can continue until the child reaches age 31, ensuring that the assets are handled by experienced trustees who can make informed investment decisions. This feature is particularly valuable when dealing with substantial retirement accounts or in cases where the beneficiary may lack financial sophistication.

Another significant advantage is the protection it offers against premature withdrawals. By preventing the child from accessing the entire inherited IRA before age 31, the trust helps preserve the long-term growth potential of the assets. This can be crucial in situations where there are concerns about a young beneficiary's ability to manage sudden wealth responsibly.

Conduit trusts also allow for optimization of the distribution period by utilizing the child's life expectancy. This can result in smaller required minimum distributions (RMDs) in the early years, potentially leading to greater tax efficiency and allowing more of the assets to remain invested for growth.

However, conduit trusts also come with notable drawbacks. Perhaps the most significant is the requirement that all distributions from the inherited IRA must be passed out to the child. This lack of flexibility can be problematic if the goal is to provide long-term financial security or if there are concerns about the child's spending habits or financial maturity.

One major disadvantage of conduit trusts is the requirement to distribute the entire account balance to the child at age 31. This mandatory distribution can result in a significant taxable event and may not align with the original account owner's wishes for long-term financial support or asset protection.

In weighing these pros and cons, it's clear that while conduit trusts offer valuable benefits in terms of professional management and preventing early depletion of the inherited IRA, they may not be suitable for all situations. Families concerned about long-term control over distributions or those dealing with very large retirement accounts might find the inflexibility of conduit trusts challenging. In such cases, other options like accumulation trusts or age 31 trusts might be more appropriate, depending on the specific circumstances and goals of the estate plan.

Ultimately, the decision to use a conduit trust should be made in consultation with experienced estate planning professionals who can evaluate the unique needs of the family and the beneficiary, the size of the retirement account, and the long-term objectives for the inherited assets.

Accumulation trusts offer a nuanced approach to managing inherited retirement assets under the SECURE Act, presenting both significant advantages and notable drawbacks. One of the primary benefits of these trusts is their flexibility in distribution control. Unlike conduit trusts, which must pass all distributions directly to beneficiaries before the end of year, accumulation trusts allow trustees to retain distributions from inherited IRAs within the trust. This feature provides greater control over the timing and amount of distributions to beneficiaries, which can be particularly valuable when there are concerns about a beneficiary's financial maturity or when long-term asset preservation is a priority.

The extended asset protection offered by accumulation trusts is another key advantage. By keeping assets within the trust structure, these trusts can shield the inheritance from creditors, potential divorce proceedings or poor financial decisions by the beneficiary. This protection, coupled with the opportunity for ongoing professional management, makes accumulation trusts an attractive option for larger accounts or situations where beneficiaries may lack financial sophistication.

In addition, accumulation trusts can be designed to benefit multiple beneficiaries, offering more versatility in estate planning. For eligible designated beneficiaries (EDBs), these trusts may also provide the potential for longer tax deferral, allowing for distributions to be stretched over the beneficiary's lifetime and maximizing tax-deferred growth.

However, the advantages of accumulation trusts come with significant trade-offs, primarily in the realm of taxation. Perhaps the most notable disadvantage is the compressed tax brackets applicable to trusts. As of 2024, trusts reach the highest federal tax rate of 37% at just $15,200 of taxable income, a threshold significantly lower than that for individual taxpayers. This can result in substantially higher overall taxes compared to scenarios where distributions are made directly to beneficiaries who may be in lower tax brackets.

The complexity of administering accumulation trusts is another consideration. These structures require more intricate accounting and management, which can increase costs and the potential for administrative errors. There's also the risk that if not properly structured, an accumulation trust might fail to qualify for the favorable tax treatment intended for certain beneficiaries under the SECURE Act.

From the beneficiaries' perspective, the reduced direct control over the inherited assets may be seen as a drawback. While this can be advantageous in protecting assets, it may lead to conflicts between trustees and beneficiaries who desire more frequent or larger distributions. Additionally, depending on how the trust is structured, there may be limitations on investment choices compared to individual ownership of an inherited IRA.

The age 31 trust is a new tool created by Treasury regulations for beneficiaries who don't qualify as EDBs. An age 31 trust can provide professional management, creditor protection and trustee control of assets until the beneficiary reaches 31, while still being eligible for the 10-year income tax deferral under the SECURE Act.

Key features of an age 31 trust include:

• All retirement assets must be distributed outright to the young beneficiary by the end of the calendar year in which they turn 31.
• It functions as an accumulation trust and can have multiple beneficiaries.
• Beneficiaries other than the young beneficiary receiving assets at 31 are disregarded for RMD purposes.
• The 10-year rule applies since the young beneficiary is not an EDB.

The SECURE Act has significantly altered the landscape of estate planning for retirement assets, particularly when it comes to young beneficiaries. While the elimination of the "stretch IRA" strategy has created new challenges, various trust structures such as conduit trusts, accumulation trusts and age 31 trusts offer potential solutions. Each option comes with its own set of advantages and disadvantages, particularly in terms of tax implications and distribution control. As the rules governing inherited retirement accounts continue to evolve, it's important for individuals and families to consider working closely with experienced estate planning professionals to develop strategies that balance tax efficiency, asset protection and long-term financial security for their beneficiaries.