Providing for Minor Children After SECURE

Your clients are young parents, setting up an estate plan to provide for their children if both parents should die while those children are still too young to fend for themselves. The clients' principal assets are their home and their retirement plans (401(k)s and IRAs). How can they best structure the children's inheritance to maximize the funds available for their care and education?

The SECURE Act of late 2019 has made this always-daunting planning problem more difficult. Prior to 2020, retirement benefits left to a "see-through trust" for the child's benefit could be distributed, after the client's death, in annual installments over the child's life expectancy. Because of the child's long life expectancy, these annual required minimum distributions, or RMDs, were very small. If the trust benefited several children, the oldest child's life expectancy applied, but it was still very long, and the resulting RMDs were still very small.

The trustee could withdraw the tiny RMD and use that money, plus additional withdrawals as needed, to pay for trust expenses and all the child's needs. Funds withdrawn from the IRA would be taxed at the child's (low) rate, and funds not currently needed could be left in the IRA for further tax deferral.

SECURE put a stop to this. SECURE replaced the "life expectancy payout" with a mandatory 10-year payout for most beneficiaries. But wait! The life-expectancy-payout method still applies to certain beneficiaries called "eligible designated beneficiaries," or EDBs, right? And a "minor child of the participant" is an EDB, right? So, what's the problem?

There are several problems.

The first problem is that the minor child's status as an EDB ends when he or she "reaches majority," at which time the life expectancy payout ceases and the 10-year rule kicks in: The entire retirement plan must be distributed by the end of the year that contains the 10th anniversary of the child's "reaching majority." This payout scheme will apply to benefits left outright to the minor, or to a custodian or guardian for the minor, or to a "conduit trust" for the child's benefit. Under a conduit trust, all distributions from the IRA must be passed out to the child (or spent for his/her benefit or used to pay trust expenses) as long as that child lives--including distributions made under the 10-year rule. Unless the IRS changes this rule by future regulations, a trust that is not a conduit trust will not qualify for the minor's EDB status, even if he/she is the sole life beneficiary and the trust qualifies as a see-through trust.

Other problems: Congress has left it up to the Treasury to define what "majority" means. Regulations have used age 26 as the potential endpoint of "minority" status for another pension-plan purpose, but pending issuance of regulations for this Code section, planners need to assume the state law definition (for some, age 18, for others, age 21) may apply. Another important matter that must await regulations is the treatment of a trust for multiple minor children of the participant. Does the 10-year rule kick in when the oldest one reaches majority? Or when exactly?

Now, if the client wants the "traditional" IRA-funded trust for a minor child, with the trustee withdrawing the annual RMD plus whatever else is required to pay for the child's needs, that will still work fine, with these two changes:

• It will only work for one child (until the Treasury sorts out the "multiple minors" question).
• It will end (with full distribution of the entire IRA to the child) no later than age 28 (or perhaps 31 if child lives in an age-21 majority state--or perhaps as late as age 36 depending on how the Treasury decides to define "majority").

As you can see, that very limited structure might work just fine for the parent with one young child and whose retirement assets are small enough that full distribution by age 28 (or 31, or 36!) is acceptable. In that situation, the post-SECURE conduit trust for a minor child will work very similarly to the pre-SECURE conduit trust for the minor child. The life expectancy payout won't continue for the child's entire life--but that's not a big deal if the amount in the IRA is not much in excess of what will be needed to get the child raised to adulthood.

If the client has two children? Again, it could work if the IRA could be left to separate equal trusts, one for each child, and otherwise as above, or to a joint trust for both children if it would be acceptable to have full distribution within 10 years after the older one attains majority.

The not-so-easily-solvable planning problem is for the client whose retirement benefits exceed the amount likely to be spent raising that minor child to adulthood. Perhaps the client expected the substantial retirement plan to be used, not just for food, clothing, and tuition during youth, but to establish an inheritance through a lifelong "life expectancy payout." Or perhaps the parents just want to be sure their IRA money, like their other assets, will be protected in trust for their children's benefit, not just during childhood and adolescence, but until they reach an age of hopefully more mature judgment, such as 35, 40, or 45 years--popular distribution-age choices for clients trying to protect their children from impulsive immature youthful spending decisions.

For these clients, the choice is stark: The only way to avoid giving the child full outright distribution of the retirement benefits within 10 years after attaining majority is to leave the benefits to a trust that does not qualify as an EDB and will be subject to the 10-year rule (at best) upon your death and will pay income tax on the benefits held in the trust at high trust tax rates.

Does that sound harsh? It certainly is. That is the result SECURE intended when it eliminated the life expectancy payout. The purpose of SECURE's changes was to raise revenue by increasing and accelerating the income taxes on inherited retirement benefits.

Planners are scouring the landscape for ways to "beat" SECURE. They are looking for a way to tie up a retirement plan in trust for a child's lifetime without making the retirement benefits taxable at high trust rates. Until that holy grail is found, clients and planners need to face facts. If the conduit trust model is not right for this client, prepare to pay high trust income tax rates and (if necessary) buy life insurance to pay those taxes. It is more important to have the best substantive trust terms (providing exactly what the clients want for the care of their children) than to draft a contorted instrument in an attempt to qualify for SECURE's miserly life expectancy payout for minor children.

Correction: An earlier version of this article listed an incorrect age for full distribution of traditional IRA-funded trusts.

Natalie Choate is an estate planning lawyer in Boston with Nutter McClennen & Fish LLP. Her practice is limited to consulting regarding retirement benefits. The new 2019 edition of Choate's best-selling book, Life and Death Planning for Retirement Benefits, is now available through her website, www.ataxplan.com, where you can also see her speaking schedule and submit questions for this column. The views expressed in this article may or may not reflect the views of Morningstar.