The Internal Revenue Service (the "Service") issued the 2020 version of Publication 590-B "Distributions from Individual Retirement Arrangements (IRAs)" on March 25, 2021, to assist taxpayers with understanding how their retirement accounts are taxed, how to calculate required distributions, and how they should report distributions from such accounts. It should have been a quiet affair, attracting little attention. While a publication like this cannot be relied upon as authoritative guidance of any sort, tax planners would normally try to "read the tea leaves" to see what the IRS position may be on some issues related to the SECURE Act, about which further guidance is needed while awaiting regulations. Unfortunately, the Publication made some startling and contradictory statements about the operation of the SECURE Act with respect to inherited IRAs, the operation of the 10-year rule and to whom it applies, and under what circumstances. (A detailed analysis of Publication 590-B is beyond the scope of this article. For more information on the various issues presented by Publication 590-B, including some actual clarifications of policy, I direct you to Natalie Choate's excellent commentary on the subject, "Natalie Choate's Guide to the New IRS Publication 590-B." You can access the article here.)
The most concerning portion of the Publication for most practitioners was likely the example provided on page 12, which seemed to indicate that a designated beneficiary subject to the 10-year rule would have to take required minimum distributions annually using the life expectancy method over the first nine years and then take all remaining funds in the final year. It is probably safe to say that no one believed that the statutory language of the SECURE Act required any such annual life expectancy payouts for designated beneficiaries when the 10-year rule applied, and many were confused as to how the Service could come up with such an interpretation. Predictably, some practitioners began to panic and nervous emails and listserv messages went back and forth for a few days, until most practitioners concluded that the Service is simply in error on this one. As of this writing, Publication 590-B is still in circulation, but there have been suggestions by those "in the know" that the Service is planning to issue a revised version.
Fortunately, it seems this cause for confusion is temporary, and there likely is no need to panic. However, it does perhaps serve as a reminder for estate planners to draft their documents in a way that allows for flexibility in addressing matters that are unknown or untested. Even as we sit today, we have no official guidance from the Service as to how the SECURE Act fits within the pre-SECURE framework of regulations, or how certain aspects of the SECURE Act will be interpreted. Nevertheless, attorneys and other advisors must help their clients plan for the disposition of their retirement benefits in the most tax-efficient manner possible while still staying within the overall intent of the plan.
To illustrate the challenges posed by the SECURE Act, and the reason it serves as an example of the need for flexible, cautious drafting, it is necessary to provide a bit of background on that legislation.
With respect to see-through trusts, the SECURE Act changed the considerations in so-called conduit and accumulation trust drafting by creating a new category of designated beneficiary (the eligible designated beneficiary or "EDB") and by creating a new applicable distribution period that would apply to non-EDBs or (stealing Natalie Choate's phrase) plain old designated beneficiaries – "PODBs." Certain EDBs (spouses, disabled or chronically ill individuals, and individuals less than 10 years younger than the plan participant) are eligible for life expectancy payouts over the applicable distribution period. In contrast, retirement benefits payable to PODBs are now generally required to be paid out no later than the end of the 10th year following the participant's date of death (often referred to as the 10-year rule, because it is based on the 5-year rule that applies if there is no designated beneficiary at all).
For the classes of EDBs referenced above, the usual see-through rules should apply such that the EDB's life expectancy is used for determining the applicable distribution period and required minimum distributions. However, there is one category of EDB to which different rules apply – the minor child of the retirement plan participant. In this case, life expectancy payouts can be made during the child's minority, but the applicable distribution period flips to the 10-year rule when the child reaches "majority." Further, upon the death of any EDB, the SECURE Act provides that the 10-year rule becomes the new applicable distribution period for any funds remaining in the retirement account that were not distributed prior to the death of the EDB. As a result of the changes to the distribution period at the death of the EDB (or in the case of the minor child upon the child attaining majority), it is necessary for see-through trust provisions to be drafted in a way that contemplates both the life expectancy payout and the 10-year rule.
With respect to required minimum distributions, while it seems clear to us that the 10-year rule is supposed to operate like the 5-year rule in the sense that distributions are not required at any given time but the entire amount of the retirement benefits must be withdrawn by the end of the 10th or 5th year (as applicable), we also recognize that the Service could have some other interpretation (whether that was life expectancy payout over the 10-year period as suggested in Publication 590-B or a series of equal annual distributions or some other scheme). In recognition of this uncertainty, required minimum distributions are broadly defined in our documents as the amount required to be withdrawn in any given year of the applicable distribution period to avoid a penalty. We added flexibility by explicitly giving the Trustee discretion to refrain from making withdrawals from the retirement account if not required by law to do so as long as the full amount is withdrawn by the end of the applicable distribution period.
Drafting for the applicable distribution period was more challenging because of the temptation to use a simple 10 year term in the case of PODBs. Pre-SECURE, of course, the conduit designated beneficiary's life expectancy would be used to determine the applicable distribution period for retirement assets passing to a conduit trust. Post-SECURE, the applicable distribution period could be life expectancy or 10-years, depending on the identity of the conduit beneficiary. Because it is unknowable to some extent whether any given trust would be for an EDB or a PODB at the drafting stage, it was necessary to ignore temptation and to define the applicable distribution period simply and broadly as the longest period permitted under the Code and Regulations. This way, even if the Code or Regulations change over time or if the expected beneficiary is an EDB or a PODB, the applicable period will always be whatever the longest possible period would be at any given time under any circumstance.
For accumulation trusts, the pre-SECURE see-through trust regulations (which remain in effect) require that all beneficiaries are individuals, and that it be possible to determine all the beneficiaries (including remainder beneficiaries) so that the beneficiary with the shortest life expectancy can be identified. (In a conduit trust, the identity of the remainder beneficiaries is irrelevant because all retirement benefits must be paid out to the conduit beneficiary.) With the exception of certain accumulation trusts for EDBs who are disabled or chronically ill, it seems clear that the 10-year rule will generally apply because the remainder beneficiaries are unlikely to be EDBs. However, even if they are all EDBs, it is unclear what the effect would be. Thus, similarly to conduit trusts, accumulation trusts must contemplate the uncertainty of what distributions during the applicable distribution period must be and a similar solution was used to define the required minimum distributions.
With respect to the applicable distribution period for accumulation trusts, it logically seems superfluous to worry about determining the beneficiary with the shortest life expectancy for a trust that has a payout over a term certain. However, because the current regulations remain applicable to accumulation trusts, it is prudent to draft the trust in such a way that all potential beneficiaries can be determined, and it is possible to identify the potential beneficiary with the shortest life expectancy, in the event that requirement under the regulations still applies. Defining the applicable distribution period then as the longest permissible period is the cautious approach.
The SECURE Act did try to carve out an exception for certain accumulation trusts for EDBs who are disabled or chronically ill to allow the use of the life expectancy payout during the EDB's lifetime. However, it did not make it clear whose life expectancy applies – the chronically ill or disabled EDB or the oldest potential beneficiary, including remainder beneficiaries. While it seems that Congress intended that the disabled or chronically ill EDB's life expectancy be used, it did not in fact add that rule to the statute. As a result, such trusts seem to still be subject to the accumulation see-through regulations which could mean that a remainder beneficiary who is older than the EDB could cause a shorter applicable distribution period than expected. In an effort to address the probable Congressional intent, it may be best to include in accumulation trusts language specifically indicating the Signer's expectation that the disabled or chronically ill EDB's life expectancy will be used to determine the applicable distribution period. However, the trust should also indicate that notwithstanding such expectation, the applicable distribution period is the longest permissible period under the Code and regulations, meaning the life expectancy of the oldest remainder beneficiary, if that rule is deemed to apply.
Drafting for flexibility and to meet the ever-changing laws and best practices is a foundational goal at InterActive Legal. We know that no one tax regime will be here forever – it constantly evolves and our practice and program evolve with it. Accordingly, the conduit and accumulation trust provisions in the InterActive Legal documents include the savings clauses and provisions intended to provide the flexibility described above. Although this leads to a bit more complexity in drafting, we want our subscribers to feel confident that the provisions in their documents will stand the test of time and be able to meet whatever changes, requirements or regulations issue from the Service.
Where we can anticipate other changes that seem likely, such as a reduction in the estate tax exemption, we offer other solutions for flexibility, like model language to make gifts limited to the applicable exemption amount. Because the increased estate tax exemption will sunset in 2026 regardless of whether the Biden Administration is able to enact its proposed changes, lifetime gifts will be the right planning move for many high net worth clients and the formula limitation on the gift may mitigate against reductions in the exemption amount that take effect this year (or next year for those reluctant to pull the trigger). While less likely to pass, the possible limitation on applying GST exemption to trusts that may last longer than 50 years that has been proposed by Senator Sanders will affect all long-term trusts if passed. For that reason, we will be adding options to the program to address that possibility. Change may be coming – as I write this, President Biden released his plan for increasing taxes on wealth transfer and we will need to wait to see the details to understand how close it comes to the proposals from Senator Sanders and Senator Van Hollen. Regardless of which changes eventually come to pass, now is the time for estate planners to address these and other possible changes through cautious and flexible drafting.
Elizabeth ("Beth") Boehmcke, Esq.
Attorney, Director of Content Development, InterActive Legal
Elizabeth (“Beth”) Boehmcke graduated cum laude from the University of Michigan Law School in 1993. After graduation from law school through 2003, she specialized in high net worth estate planning, with an emphasis on cross-border and asset protection planning, and the representation of fiduciaries managing complex trusts and family businesses.
During her career in New York, she was an associate attorney at both Rogers & Wells (now Clifford Chance) and Hodgson Russ in New York City. After a hiatus in her legal career to care for her children, she resumed her legal career by passing the Virginia bar in 2014 and began working for the Hook Law Center, P.C., where she expanded her estate planning practice to include elder law, specifically focusing on asset protection planning for Medicaid and Veteran’s benefits.
She is a proud graduate of the University of Virginia where she received a B.A. with distinction in Psychology in 1988 and is also a graduate of SUNY-Buffalo where she received an M.A. in Clinical Psychology in 1990.