Updating Estate Plans for the SECURE Act

The Setting Every Community Up for Retirement Enhancement (SECURE) Act was enacted on December 20, 2019. The Act made a number of changes to how retirement plans function, such as increasing the age at which retirement plan participants need to take required minimum distributions (RMDs) to 72, making it easier for small business owners to set up and maintain retirement plans, and allowing many part-time workers to participate in a retirement plan. However, the SECURE Act made an important change that impacts the see-through trust rules, which will require many individuals to update their revocable living trust agreements and estate plans.

Prior to the SECURE Act, non-spouse beneficiaries who inherited a retirement plan or IRA (i.e., descendants of the IRA owner) could qualify to "stretch" their inherited IRA and take RMDs calculated based on the descendant's life expectancy. This was generally a good thing because it resulted in the maximum deferral of income taxes, and trusts were drafted to help ensure that this stretch opportunity was realized where a trust was named as the beneficiary of an IRA. I discussed how trusts can qualify as beneficiaries of an IRA in a prior post.

The SECURE Act largely eliminated the law that allowed non-spouse IRA beneficiaries to stretch IRA distributions over their life expectancy. Now, most non-spouse beneficiaries must receive (and take into income) the entire IRA account balance within ten years of the death of the account owner, regardless of whether the beneficiary or a trust for the beneficiary's benefit was the named IRA beneficiary. There are good reasons why an account owner would want to name a trust as the beneficiary of their IRA, such as protecting an imprudent beneficiary from squandering an inheritance, including inherited IRA funds. This need still exists, but because of the SECURE Act, many trust provisions describing the trustee's obligations with respect to IRAs need to be changed.

Specifically, many trust agreements drafted before the SECURE Act provided that trust beneficiaries would receive their inheritances in a continuing trust known as as a "conduit trust" for IRA purposes. A conduit trust requires the immediate distribution of all funds withdrawn from the IRA to the individual trust beneficiary. The ten-year rule under the SECURE Act would, therefore, result in trust beneficiaries receiving all of the inherited IRA funds ten years after the account owner's death. A large, mandatory trust distribution at a fixed time during a trust beneficiary's life is inconsistent with what most trustmakers intend in naming trusts as IRA beneficiaries in the first place. Even worse, however, is that trusts that are not amended to function appropriately under the SECURE Act and which are designated as IRA beneficiaries could even result in the ten-year stretch being reduced to five years.

Most post-SECURE Act trust agreements will have beneficiary's continuing trusts qualify as "accumulation trusts," as opposed to conduit trusts, for IRAs paid to such trust, which would not require the immediate distribution of IRA funds. Post-SECURE Act trust agreements will also be drafted consistent with the SECURE ACT's exception to the ten-year IRA payout rule for individual beneficiaries less than ten years younger than the account owner and disabled and chronically ill individuals, who can continue to take distributions over their their life expectancy. Disabled beneficiaries in particular may benefit from inheriting an IRA through a continuing trust, but it is critical that such a trust be calibrated to the SECURE Act to ensure the lifetime stretch opportunity is preserved. In sum, now is the time to update your estate plan so that it functions properly under the SECURE Act.

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Creating Individual Inherited Retirement Accounts from a Trust Account

As I discussed in a previous post, a trust may be named as the beneficiary of a retirement plan upon the plan owner's death. There are complications and disadvantages of doing so, but there are potentially important reasons to name a trust as a retirement plan beneficiary. For example, naming a supplemental needs trust created for an individual with special needs as a retirement plan beneficiary, instead of the individual, will prevent the individual from ceasing to qualify for means-tested public assistance due to inheriting the retirement account.

Upon the termination of the trust that is the named beneficiary of a retirement account, any amounts remaining can be passed to the remainder beneficiaries of the trust intact, meaning in a manner that is not treated or reported as a taxable distribution from the retirement account. Instead, the transfer is treated as a plan-to-plan transfer to individual accounts established for the remainder beneficiaries of the trust.

In my experience, the custodian of the retirement account often requests a reference to legal authority that would allow the transfer of the retirement account from a trust account to separate account(s) in the individual name of the trust beneficiaries. IRS private letter ruling 200750019 is one such authority wherein the IRS permitted a trust that was a retirement plan beneficiary to be bypassed and separate, inherited IRA accounts established for the trust beneficiaries. While not binding, this ruling indicates that the IRS regularly permits this practice and can help assure a custodian that this practice is permissible.

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Trusts as Beneficiaries of Retirement Plans

In order to qualify as a "retirement plan" under the Internal Revenue Code, 401(k)s, individual retirement accounts, and other retirement arrangements must be distributed to the employee that owns the plan or that employee's designated beneficiaries pursuant to I.R.C. § 409(a)(9) and the accompanying regulations. For purposes of these rules, only individuals are permitted to be designated beneficiaries of a retirement plan. One reason for this is so that required minimum distributions can be calculated.

However, if certain requirements are met, a trust may be named as the beneficiary of an employee's retirement plan, and the individual beneficiaries of the trust will be treated as having been designated as the plan beneficiaries. For an excellent breakdown of how the required minimum distribution rules work where a trust is a beneficiary, see the chart prepared by Keebler and Associates located here. Naming a trust as a beneficiary of a retirement plan can be a useful estate planning technique, but after the employee passes away, the custodian of the retirement plan will need assurance that the requirements described in Treas. Reg. § 1.401(a)(9)-4 are satisfied.

These so-called "see-through" rules for a trust will be satisfied after the employee's death if the beneficiaries of the trust with respect to the retirement plan, if not specified by name, are identifiable from the trust instrument and certain documentation is provided to the custodian. The documentation requirements include (1) a list of all of the current beneficiaries of the trust, (2) a list of all the contingent and remainder beneficiaries of the trust as well as a description of the conditions on their entitlement, (3) a certification that this beneficiary list is correct.

Finally, the trust must be valid under state law and be irrevocable, and the trustee must agree to provide a copy of the trust instrument to the custodian upon demand. The trust agreement should be drafted with these rules in mind by restricting distributions of any retirement plan assets to individual trust beneficiaries and requiring that such assets be distributed in accordance with I.R.C. § 409(a)(9) and the regulations. Compliance with these rules will allow a trust to be a designated beneficiary of a retirement plan.

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Benefits Governed by ERISA

The Employee Retirement Income Security Act of 1974 (ERISA) was passed to protect employee benefit plans and require disclosures pertaining to such plans. With certain exceptions, ERISA governs any employee benefit plan that is established or maintained by an employer or employee organization. An "employee benefit plan" refers to a plan, fund, or program that provides ERISA-type benefits.

In summary, five elements must be present in order for an ERISA plan to exist: (1) a plan, fund, or program (2) that is established or maintained (3) by an employer or employee organization (4) for the purpose of providing ERISA-type benefits (5) to participants or their beneficiaries. See Moorman v. UnumProvident Corp., 464 F.3d 1260 (11th Cir. 2006).

Not all employee benefits rise to the level of a "plan, fund, or program." For example, a informal employer practice, which isn't communicated to employees, of providing benefits to long-time employees after retiring may not constitute a plan, fund, or program. The test is whether "a reasonable person could ascertain the intended benefits, a class of beneficiaries, the source of financing, and procedures for receiving benefits."

A number of factors are used in determining whether a bona-fide plan or program has been "established or maintained" by an organization. These include "(1) the employer's representations in internally distributed documents; (2) the employer's oral representations; (3) the employer's establishment of a fund to pay benefits; (4) actual payment of benefits; (5) the employer's deliberate failure to correct known perceptions of a plan's existence; (6) the reasonable understanding of employees; and (7) the employer's intent."

Some organizations can establish and maintain a plan to provide ERISA-type benefits without actually creating an ERISA employee benefit plan if the organization is not an employer or employee organization. Where there are no actual employees receiving benefits, such as a partnership providing benefits solely to its non-employee partners, there is no ERISA plan. An employee organization is one in which the employees/members participate and which exists for the purpose, in whole or in part, of dealing with the employees' employer.

"ERISA-type benefits" include (1) retirement income to employees or deferred income beyond employment and/or (2) certain other benefits, most notably insurance. Such employee benefit plans are referred to respectively under ERISA as (1) pension benefit plans and (2) welfare benefit plans, with the former having significantly more requirements under the law. Finally, as referenced earlier, no ERISA plan exists without a defined class of beneficiaries that include at least some employees.

Employers should be aware of these rules in order to avoid inadvertently creating an ERISA plan. It is worth noting, however, that because ERISA preempts state law, it is often preferable for an employer to have an ERISA plan depending on the situation. Such questions can be answered by a competent benefits attorney.

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Social Security Planning

Normally, in planning when to apply for social security benefits, it makes sense (assuming you expect to live a long time) to delay applying. However, for some married couples, the "file and suspend" strategy results in greater benefits, even though it runs somewhat counter to the normal strategy. According to the Social Security Administration,

If you and your current spouse are full retirement age, one of you can apply for retirement benefits now and have the payments suspended, while the other applies only for spouse's benefits. This strategy allows both of you to delay receiving retirement benefits on your own records so you can get delayed retirement credits.

The practical effect of this technique is explained by the AARP in the following example:

John and Mary, a married couple... are 66, which is their full retirement age. Mary is retired; John plans to keep working until he is 70.

At 66, John, who had a bigger income than Mary over the course of his career, files for his full retirement benefits of $2,000 a month, but immediately suspends payment. By doing that, he will begin accruing delayed retirement credits: For each year that he keeps his payments in suspension, they'll be 8 percent higher when he does take them. The credits top out at age 70. Since John's basic retirement benefit at age 66 was $2,000, his new payment if he waits until 70 to collect will be about $2,640, plus any cost-of-living increases.

When John filed for his benefits, he automatically activated Mary's ability to apply for a spousal benefit... equal to up to one-half of the other spouse's retirement benefit. So Mary can collect $1,000 a month [without even] taking her own retirement benefit...

This means that the couple in this example receives $12,000 per year without receiving any retirement benefits on their own record, which they will start doing at a later date. This is an example of how the wrong strategy for collecting social security benefits can mean the receiving tens of thousands of dollars less than would otherwise be possible. Just as an attorney should be consulted for estate planning or other legal questions, a financial planner with social security expertise should be consulted when planning for retirement.

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Medicaid Eligibility for a Married Individual

Medicare is a federal entitlement program available to seniors regardless of need and works like health insurance. In contrast, Medicaid is a health benefit program for low-income individuals. "Medicaid planning," normally refers to qualifying for long-term care benefits under Medicaid. Long-term care costs thousands of dollars per month and coverage is not available under Medicare and most health insurance plans. This post will focus on Medicaid qualification in Utah for a married individual.

In order to be eligible for Medicaid, an applicant cannot have more than $2,000 in assets. However, some assets do not count toward this limit; moreover, some "countable" assets can be converted to "non-countable" assets. First, an in-state residence is not a countable asset unless the applicant does not intend to return home and no spouse or dependent lives there. The cash value of a life insurance policy up to $1,500 is exempt, as is up to $1,500 that is specifically designated as a funeral fund. Irrevocable prepaid funeral plans, cemetery plots, and household items are also exempt. It is generally permissible to purchase these items or pay down a mortgage or other debts in order to reduce countable assets and qualify for Medicaid. However, the applicant cannot have more than $525,000 of equity in a residence.

In addition, spouses of applicants who live at home can keep some assets. A Medicaid worker will value all of a couple's countable assets and divide by two. The spouse can keep half, with a minimum of around $23,000 and a maximum of around $114,000 (which changes each year). The applicant is still limited to $2,000 of assets, meaning that if the couple has more than $25,000 in total non-exempt assets, the excess attributable to the applicant spouse must be spent down before they will qualify for Medicaid. In addition, the non-applicant spouse can keep some of the income of the applicant spouse once the applicant spouse is in a nursing home.

Certain transfers of assets do not affect Medicaid eligibility, such as transfers to a spouse or certain transfers to disabled individuals. However, nearly all other transfers made within five years prior to applying for Medicaid are of no benefit for eligibility purposes because applicants must report all such transfers made for less than fair market value. Making transfers of non-exempt assets within this timeframe will be detrimental due to the Medicaid sanction rules.

It is critical that an individual consults with a Medicaid expert before applying in order to avoid making transfers that will result in sanctions or spending assets they would have been allowed to keep. Proper planning will allow a spouse remaining at home to be more financially secure.

The state will seek to recover funds paid by Medicaid from the estate of a recipient after the death of the recipient and the surviving spouse, so long as there is no minor or disabled child. Even though an asset may have been exempt for Medicaid qualification purposes, it will not be exempt from estate recovery. For more information, including the sources for this post, see the pamphlets provided by the Utah Department of Health entitled “Estate Recovery Information Bulletin”, DWS 05-994, "Nursing Home Information, May we be of service to you?” DWS 05- 969, and “Assessment of Assets” DWS 05-992.

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Savings Incentive Match Plan for Employees

A Savings Incentive Match Plan for Employees (SIMPLE Plan) is a written salary-reduction arrangement that allows small businesses that meet certain requirements to make retirement contributions on behalf of eligible employees. A SIMPLE Plan "is ideally suited as a start-up retirement savings plan for small employers not currently sponsoring a retirement plan." A SIMPLE Plan is established by a written agreement and setting up Individual Retirement Accounts for employees.

In order to be eligible to establish and maintain a SIMPLE Plan, a business can not maintain or sponsor another retirement plan and must have 100 or fewer employees who earned $5,000 or more in the prior year. All of the employees in this category are eligible to participate in the plan and the employer may not impose more restrictive eligibility requirements. The employer is required to make either a non-elective contribution of 2% of each eligible employee’s compensation or a match of the employee’s elective salary reduction of up to 3% of the employee’s compensation.

Employees can make salary reduction contributions up to $12,000 in 2013, plus catch-up contributions of $2,500 for individuals 50 or older. Elective deferrals of an employee’s wages are included in Form W-2 wages for social security and Medicare purposes only. Employer contributions to a SIMPLE Plan are excluded from the gross income of the employee and deductible by the employer.

While the contribution limits of a SIMPLE Plan are lower than some other small employer retirement plan options, SIMPLE IRA Plans do not have the start-up and operating costs of other plans, nor is there any filing requirement for the employer. Furthermore, because SIMPLE Plan contributions can reduce salary, they can be used to reduce payroll or self-employment tax when compared to some other retirement plans.

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