2020 has ushered in a host of legal and tax changes. Below is a discussion of the changes that most impact estate planning.

Significant Changes in IRA Distribution Rules

In December, as part of the federal appropriations bill, Congress passed and the President signed the SECURE Act, which significantly changes the rules governing distributions from IRAs and qualified employer retirement plans, such as 401k plans.

On the positive side, the SECURE Act increases from 70½ to 72 the age at which IRA and qualified plan participants who turn 70½ after December 31, 2019 must begin taking required minimum distributions, allows taxpayers over age 70½ with earned income to make IRA contributions, and provides some incentives for small businesses to establish retirement plans.

To help pay for these changes, the SECURE Act significantly reduces – to a maximum of 10 years for most cases in which the beneficiary is not the participant’s spouse – the time period after the death of an IRA or qualified plan participant over which the participant’s beneficiaries may take distributions and thereby defer income tax, largely eliminating the popular post-death planning technique of a “stretch IRA.”

Although IRA and qualified employer retirement plan participants will not be forced to change their beneficiaries or, if applicable, trust documents, as a result of the SECURE Act, the SECURE Act might make it desirable for some individuals to modify their beneficiary designations or, where a trust is a primary or contingent beneficiary, related trust provisions

Distribution Rules Prior to the SECURE Act

Federal tax law has long included important, but complicated, rules regarding required distributions from an IRA or qualified plan after the participant’s death.  Those rules required that the entire IRA or plan be distributed and taxed within 5 years following the participant’s death if the IRA or plan had no beneficiary, or if the beneficiary was the participant’s estate or a trust that did not qualify as a “see-through trust.”  In contrast, those rules allowed the participant’s spouse to roll over the participant’s IRA or plan to the spouse’s own IRA or take advantage of other spousal options when the spouse was named as beneficiary.  In addition, when the beneficiary was an individual other than the participant’s spouse or a trust that qualified as a “see-through trust,” those rules allowed IRA distributions to be made, and thereby taxed, to the individual or the trust based on the individual’s or designated trust beneficiary’s life expectancy. 

Use of “See-Through Trusts”

The see-through trust option allowed IRA and qualified plan participants to take advantage of the control, creditor-protection, and other benefits of a trust for their desired non-spouse beneficiaries while still fostering income-tax deferral long after their deaths (instead of being subject to compressed 5-year distributions). 

Accumulation trusts may retain IRA distributions they receive during the current beneficiary’s life, but have limits on who may be a recipient of any remaining trust assets after that beneficiary’s death, thereby making accumulation trust qualification difficult in some cases. With conduit trusts, on the other hand, the trustee is required to distribute to the current beneficiary any IRA distributions that the trust receives, but there are not the same limits on who may be a recipient of any remaining trust assets after that beneficiary’s death. Because conduit trust qualification is more straightforward and includes fewer traps than accumulation trust qualification, and because, for a young trust beneficiary, each required IRA distribution from a conduit trust typically is modest, our firm and many others have generally included conduit provisions in trust documents.  

SECURE Act Changes to Post-Death Distribution Rules

For a participant’s death after December 31, 2019, the SECURE Act places a maximum duration of 10 years on distributions from an IRA or qualified plan after the participant’s death, except for these beneficiaries:

• A beneficiary who is the participant’s spouse (for whom the previous planning options, including a spousal IRA rollover, continue to be available);
• A beneficiary less than 10 years younger than the participant (for whom life expectancy distributions may be made);
• A beneficiary with a disability or chronic illness (for whom life expectancy distributions may be made); or
• A minor beneficiary (for whom the 10-year time period does not start until the beneficiary reaches the age of majority).

For IRA or qualified plan participants that died on or before December 31, 2019, the SECURE Act does not impact the distribution time period for the initial designated beneficiary.  However, if that beneficiary dies before the IRA has been fully distributed, the SECURE Act changes will apply to the successor beneficiaries. 

Impact of Changes on See-Through Trusts

Now that distributions from a see-through trust may not be made over a trust beneficiary’s life expectancy in most cases, the advantages of having see-through trust provisions are much weaker.  At best, they extend the distribution period from 5 to 10 years.  In the case of conduit trusts, that much smaller advantage will sometimes be outweighed by the disadvantage of pushing out the entire IRA to the trust beneficiary in a relatively short time (10 years following the participant’s death) with the accordant loss of control, creditor-protection, and other trust benefits.  As a result, some IRA or qualified plan participants with wills or trusts that include conduit trust provisions will want to amend those documents to remove or modify the conduit provisions.

Supplemental Needs Trust Planning Opportunity

Although the SECURE Act has eliminated post-death stretch IRAs in most cases, as noted above, it preserved that option for beneficiaries with a disability or chronic illness.  As a result, it has altered the planning landscape for families with multiple children, one or more of whom have a disability or chronic illness.  If that child or those children might otherwise qualify for means-tested public benefits, naming them (or a trust for their benefit that has conduit provisions mandating annual distributions) as an IRA beneficiary would jeopardize that public benefit eligibility.  Now, in certain cases, it might be advantageous to direct an IRA to a supplemental needs trust and to design that trust as an accumulation trust.  Doing so might facilitate life expectancy IRA distributions and thereby significantly defer income taxation, while still preserving the beneficiary’s eligibility for means-tested public benefits, bearing in mind that these potential advantages should be considered in the context of the family’s overall situation. 

If you wish to discuss how the SECURE Act impacts your planning or whether, if you have a trust, a change might be considered, please contact us.

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Illinois Trust Law Overhauled

Effective January 1, 2020, Illinois replaced its Trusts and Trustees Act and certain related trust administration statutes with the new Illinois Trust Code.  The change moves Illinois trust law closer to the trust law of many other states.  In most respects, the new Illinois Trust Code does not materially differ from prior Illinois trust law.  However, it adds welcome flexibility in certain trust drafting and administration situations, while generally increasing trustee reporting obligations to beneficiaries and related beneficiary information rights. 

As with the SECURE Act changes, Illinois’s adoption of the new Trust Code will not force individuals with existing revocable trusts or wills with testamentary trusts to amend those documents to comply.  However, many might choose to amend their documents to waive certain of the increased trustee reporting obligations, particularly if they prioritize simplifying trust administration over guaranteeing beneficiary information. 

If you have any questions about this issue and how it applies to your situation, please contact us. 

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Estate and Gift Tax Inflation Adjustments and Outlook

The federal estate, gift, and GST exemption has increased from $11,400,000 in 2019 to $11,580,000 in 2020, pursuant to the scheduled annual inflation adjustments.  For those individuals seeking to use their full lifetime gift tax exemption without incurring gift tax, the inflation adjustment provides room for additional lifetime exemption gifts that do not trigger gift tax.  The Illinois estate tax exemption remains at $4,000,000, and the federal gift tax annual exclusion remains at $15,000 in 2020.

Aside from the federal inflation adjustments, the start of 2020 brings no significant changes in estate, gift, and generation-skipping transfer tax law, and we do not expect any between now and the 2020 election.  However, the election might result in future changes. 

Under current federal law, the federal estate, gift, and GST exemptions are scheduled to continue increasing annually for inflation through 2025 and then be reduced by half in 2026.  A change in political power in either direction at the federal level could result in legislation that changes the exemptions or other transfer tax rules before 2026.

The Illinois 2020 ballot will include a proposed Constitutional amendment that, if passed, will permit a progressive state income tax (i.e., one that imposes higher rates on higher-income taxpayers).  In connection with that proposed amendment, some in Springfield have suggested coupling a progressive Illinois income tax with either a repeal of the Illinois estate tax or an increase in the Illinois estate tax exemption to match the federal exemption.  Those suggestions seem designed to make an increased income tax rate more palatable for higher-income, wealthier taxpayers, many of whom have been leaving the state in recent years.

As the election approaches, we will be watching these and many other issues and will be ready to help our clients plan for any changes in applicable estate, gift, and GST tax law.

If you have any questions on how any of the law changes might impact you, we invite you to contact us. In the meantime, we offer you our best wishes for a great 2020.

This update has been prepared for general informational purposes only and should not be construed as legal advice on any specific facts or circumstances.