Share Article

The SECURE Act was the most significant and wide-sweeping retirement plan legislation adopted in well over a decade.

In addition to its direct impact on retirement plans, it triggers a need to revisit planning if your retirement account is left payable to a trust.

A retirement account, such as an IRA or 401k account, is made payable to a trust by naming the trust as beneficiary. Once the retirement account owner dies, the retirement account effectively becomes an asset of the trust. If a withdrawal is made from the retirement account, the withdrawal is transferred out of the retirement account to the trustee of the trust. Once the withdrawal is held by the trustee, the trustee will use the funds as directed by the trust agreement. Some trust agreements direct that all retirement account withdrawals are automatically distributed to the beneficiary. Other trust agreements direct that retirement account withdrawals do not have to be automatically distributed to the beneficiary and can instead be retained in the trust for future use.

Why leave a retirement account payable to a trust in the first place? There are many reasons, but the two most significant reasons are control and asset protection:

  • If a retirement account is left directly payable to an individual, the individual has full control and discretion over the retirement account. There is nothing that prevents the beneficiary from fully withdrawing the retirement account balance. The result can be disastrous for certain beneficiaries, including younger beneficiaries, beneficiaries that lack financial maturity or experience, and beneficiaries with substance or gambling addiction problems. A trust provides a platform to impose restrictions on the access and use of the retirement account.
  • While retirement accounts receive extensive protection from creditors of the original retirement account owner under federal and state law, protection is not uniformly extended to inherited retirement accounts. On the contrary, assets held through a trust can generally be protected from a beneficiary’s creditors.

Retirement accounts, including ones left payable to trusts, are subject to certain mandatory withdrawal periods. The mandatory withdrawal periods effectively establish the longest period of time over which you can defer income tax on a retirement account. Mandatory withdrawal periods are enforced with a steep 50% penalty.

Prior to the SECURE Act, there were two primary types of mandatory withdrawal periods for retirement accounts payable to a trust. First, if the trust was not structured as a “look-through trust,” the entirety of the retirement account had to be withdrawn within five years. If the trust was structured as a look-through trust, the mandatory withdrawal period was based on the life expectancy of the beneficiary. There are two kinds of look-through trusts, accumulation trusts and conduit trusts.

An accumulation trust structure does not require retirement account withdrawals to be automatically distributed to the beneficiary. The withdrawals can instead be retained in the trust for investment and future distribution. However, retaining withdrawals within the trust can have negative income tax consequences. If a retirement account withdrawal is distributed to the beneficiary, the withdrawal will generally be taxed at the beneficiary’s income tax rate. If a retirement account withdrawal is retained within the trust and not distributed to the beneficiary, the withdrawal will be taxed at the trust’s income tax rate. A trust will generally have a higher income tax rate because a trust hits the highest federal income tax rate with income of only $12,950. A single individual will not hit the highest federal income tax rate until his or her income exceeds $518,400.

A conduit trust structure requires the trustee to distribute all retirement account withdrawals to the beneficiary of the trust. As a pre-SECURE Act example, assume a beneficiary that is 30 years old and inherits a retirement account with an initial value of $1,000,000 through a conduit trust. The mandatory withdrawal period would be based on the beneficiary’s life expectancy, 53.3 years for someone that is 30 years old. The retirement account withdrawal and distribution to the beneficiary in the first year would be 1/53.3 of the retirement account, approximately $18,762. In each subsequent year, the withdrawal and distribution would be the product of: (a) the value of the account at that time; and (b) a fraction. The numerator of the fraction would always be one and the denominator would be 53.3, less the number of years for which distributions have already