Leaving pension benefits in trust for minor children

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Prior to 2020, a client’s IRA could be left in trust for their children, with the benefit of a long “life expectancy payment” allowing the IRA to be phased out over the life expectancy. decades-long life of the young beneficiary. The combination of a long deferral and small annual distributions has effectively reduced the family’s tax burden. The Secure Act of 2019 abolished these “stretched IRA” estate plans, eliminating the life expectancy payment for most beneficiaries. After 2019, only five categories of “eligible designated beneficiaries” can still receive inherited retirement benefits over a certain period of life expectancy. A newly imposed 10-year rule applies to simple designated beneficiaries who are not EDBs.

A “minor child of the employee” or the owner of the IRA (the participant) is an EDB. Unfortunately, that doesn’t mean going back to “business as usual” in planning for minor children. Their EDB status ends when they reach majority and all benefits must be distributed within 10 years of that time (instead of over 50 years of the child’s actual remaining life expectancy). The proposed IRS regulations define “reaching majority” as the age of 21, regardless of educational status or applicable state law. So, effectively, the life expectancy payment for an EDB minor child is a “life expectancy to age 31” payment, since the 100% distribution from the inherited retirement plan is required no later than 31 years.

The proposed regulations provide thoughtful and helpful interpretations to make it easier to create trusts for minor children while still qualifying for the LE payment at age 31. Unfortunately, once the dust settles, striving to qualify for that semi-stretched payout won’t produce the best estate plan for many parents of young children.

Here, in very brief summary, are the options available to parents who wish to leave an IRA in trust for the benefit of their minor child so that the IRA will qualify for an LE payment at age 31:

  • Trust providing for outright distribution before age 31. An IRA left to a trust for the sole benefit of the EDB minor child will be eligible for the LE payment at age 31 as long as the entire IRA is distributed to the child no later than age 31. The payout period will be over the life expectancy of the child, with a 100% distribution required 10 years after the child turns 21, i.e. at age 31. child as soon as the trustee receives them), or an “accumulation trust” (the trustee can hold IRA distributions in the trust for later distribution to or for the benefit of the child) (but not after the age of 31). Since either structure qualifies for the LE payment at age 31, there is no reason to use a bridge trust. The intermediate trust would eliminate the trustee’s ability to take distributions from the IRA and hold them in trust for later use, without providing any benefit under the minimum distribution rules.
  • Trust providing for outright distribution after age 31. Suppose the parent thinks the age of 31 is too young and wants the funds to be held in trust until the child turns 40. If the trust provides that the trust will end and be distributed to the child at any age after age 31, it may still be eligible for some type of life expectancy payment depending on who receives the fund if the child dies before to reach the termination age of the trust.

The person or entity who inherits the trust if the child dies before the specified age for the outright distribution of the trust fund is called a “secondary beneficiary”. The proposed regulations do not take into account the secondary beneficiary if the trust’s dissolution age is 31 or less. But if over the age of 31, the secondary beneficiary counts for the purposes of determining the distribution period of the pension benefits payable to the trust. If the secondary beneficiary is not an individual (such as a charity), the trust will not be considered a named beneficiary; he won’t even qualify for the 10-year rule. If the secondary beneficiary is an individual, we enter the somewhat elaborate scheme that the US Treasury has proposed for this form of EDB minor child trust. Remember that we have a trust for the sole benefit of the participant’s non-disabled minor child which will continue until the child reaches the age of 40 (or any other age above 31), date on which it will end and will be fully distributed to the child; if the child dies before reaching the specified age, the trust is distributed to another person (the secondary beneficiary).

  1. Because there is at least one minor EDB child who is a beneficiary of the trust, the trust will use a life expectancy payment instead of the 10-year rule. But the life expectancy used will be the life expectancy of the oldest designated beneficiary, who may or may not be the EDB minor child. For example, under a trust for the participant’s minor child, to end when the child turns 40, but which will be distributed to Uncle Oscar, now 73, if the child dies before age 40, countable beneficiaries are child (13) and uncle Oscar (73), so Oscar is the oldest designated beneficiary, and his life expectancy (16.4 years) will be used to measure the required distributions instead of that of the child (71.9 years). This rate of payment will continue until the “outer limit” distribution year.
  2. The outer boundary year, when the 100% distribution of the IRA is required, will be the year the minor child turns 31, which is approximately 18 years from now in the case of that child. 13 years old.

Note: The fact that the IRA must be distributed to the trust in the year the child turns 31 does not mean that the IRA proceeds must be paid to the child at that time. . The trust will continue, in accordance with its terms, until the child reaches the age of 40, as specified by the client who created the trust.

What this tells us is that if you want the IRA funds to be held in trust for the child beneficiary over 31, the client must carefully choose the secondary beneficiary of the trust. The client cannot choose a charity (as this would disqualify the trust), and should not choose an elderly person (as their life expectancy will dictate the annual distribution rate), if the client wishes the trust to benefit from the LE -to -payment of 31 years for the child’s trust.

The rules above seem a bit inconvenient, but at least they are reasonably simple and clear and in some ways supportive. For example, customers willing to allow outright distribution to the child at age 31 can easily qualify for the LE payment at age 31. They don’t have to use an intermediary trust and can choose any secondary beneficiary.

However, in real life, the choices can be complicated and unclear. For example, if the client has multiple children, the structure of the proposed settlement encourages the use of separate trusts (one for each child) rather than a joint or “pot” trust format that many parents might prefer. If a joint trust is used for all children, the life expectancy and payout year at age 31 of the eldest will dictate the rate of distribution, and the longer life expectancy and date payment at age 31 of the youngest child will be “wasted.”

Even if the planner designs a joint trust as the parents want, and the plan is perfectly constructed so that if the parents died now, the IRA payout would be “stretched” over the life expectancy of the eldest , if the eldest was to die one year after the parents, the payment term that was to be based on the age of 21 suddenly accelerated to 10 years after their death. Thus, even the stretch “until the age of 31 of the oldest child” cannot be guaranteed.

Before spending hours trying to navigate the maze of proposed settlements in hopes of maximizing the quasi-expandable payout available to the participant’s minor children, perhaps the planner should research the likelihood that a person of the age of the parents dies before their youngest child reaches the age of 21. Chances are, that’s not likely at all. Chances are huge that the children will have finished college and be well past the age of 21 before the parent died.

Of course, all parents should create appropriate estate plans to support their children in the event that both parents die while the children are still minors. But instead of trying to twist their desired plan to fit the rules of the proposed settlement in order (perhaps – provided people die in the “right order”) to get a few more years, why not just write the trust the way the parents want it written? Urge parents to buy term life insurance with the money, thereby saving on legal fees, to ensure their children will have enough money to raise them safely to adulthood, no matter what. either the speed or the slowness with which the retirement accounts are distributed to the trust after their death.

Natalie Choate is a lawyer in Wellesley, Massachusetts, who focuses on estate planning for retirement benefits. The 2019 edition of Choate’s bestseller, Life and death planning for retirement benefits, is available on its website, www.ataxplan.com, where you can also view its speaker schedule and submit questions for this column. The opinions expressed in this article do not necessarily reflect the opinions of Morningstar.

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