By Edwin P. Morrow, III, J.D., LL.M., MBA, CFP®, CM&AA®

Thanks to the generosity of Leimberg Information Services, we are pleased to provide you this recently published article on LISI.

EXECUTIVE SUMMARY

Section 327 of the SECURE Act 2.0, effective in 2024, will provide over $1.1 billion in new tax benefits for those in the know, but traps for the unwary. The downside is that the changes may actually be quite harmful in certain situations for surviving spouses inheriting retirement plans, causing an earlier required beginning date and higher required minimum distributions (“RMDs”) than under current law, if the new election is not timely made.

On the positive side, however, the new provision may be very beneficial for those using conduit trusts for surviving spouses, enabling an even longer “stretch” than under current law, even for Roth accounts, if the trust is properly designed and administered and the election is properly made.

Practitioners must reevaluate and reconsider (yet again) the effect of another new tax provision on the choices that married couples must make in their retirement plan beneficiary designation, the design of any trusts that may receive such benefits, and the post-mortem administration of them.  These changes are especially important for larger accounts and/or blended family situations where outright bequests are often disfavored.

FACTS

Congress recently passed the SECURE Act 2.0 of 2022 as part of its 1,653-page consolidated spending bill, which became law 12/29/2022 as part of the Consolidated Appropriations Act, 2023.^[1] SECURE Act 2.0 is a follow up, of course, to the SECURE Act passed in late 2019, and provides several dozen moderate tweaks and improvements to encourage retirement savings.  Unlike the original SECURE Act, most of these enhancements will have no effect whatsoever on how a taxpayer might plan their beneficiary designation, estate or trust.  The main exceptions to this are Section 337, which provides a welcome, though very limited in scope, fix to applicable multi-beneficiary trusts (“AMBTs”), which will be the subject of a companion article, and Section 327, which is the subject of this newsletter.

Almost every article and summary on SECURE Act 2.0 that has discussed this Section thus far vaguely mentions a benefits to surviving spouses and neglects to mention the downside risk, nor the disproportionate benefit to conduit trusts.

How much of a net benefit?  $1,101,000,000.  That is the estimated cost of this provision to the federal government for the nine years between 2024-2032, which should theoretically also be factoring in the additional tax generated.^[2]  This article will help you get your clients a piece of that pie, and not be in the category of those who will be hurt by the new provision.

To understand the impact of the new provision on surviving spouses and their conduit trusts, here is a short overview of the current law on retirement accounts inherited by a surviving spouse that are not rolled over, and those inherited by a trust for a surviving spouse (which would usually be ineligible for rollover). For simplicity of description, this newsletter may sometimes refer to inherited IRAs rather than include other inherited defined contribution retirement plans (such as 401(k), 403(b), 457(b) plans).

Quick Recap of Unique Existing Rules and Paradigms for Retirement Accounts for Surviving Spouses Inherited Outright That Are Not Rolled Over

The majority of articles that discuss planning for widows and widowers, and many well-meaning advisors, assume that it’s always in the surviving spouse’s benefit to roll over a qualified retirement plan or IRA as soon as possible after a spouse dies.  While spousal rollovers are usually the best thing to do, the devil is in learning the important exceptions.  There are often important advantages to delaying the spousal rollover that are overlooked (including the newly amended provision discussed herein).

The special spousal inherited IRA rules as currently written through the end of this year (and potentially with an election, under the new changes effective next year) delay the required beginning date (“RBD”) until the deceased owner would have turned age 73 unless the spouse rolls over,^[3] and provides that the spouse is considered the owner (“employee”) if he/she then later dies before their RBD.

I will not discuss other reasons to delay a rollover that are unchanged by SECURE Act 2.0, such as if the surviving spouse is under the age of 59 ½ and may wish to access funds before that age without 10% penalty, situations where a decedent’s qualified plan has appreciated employer stock (known as the net unrealized appreciation loophole, or “NUA”),^[4] some situations in which the decedent or spouse has after-tax funds in a plan/IRA, or situations when a qualified disclaimer may be warranted.

Thus, in the past, if an IRA owner died at age 66 when their surviving spouse was age 72, the surviving spouse could simply keep it as an inherited IRA, delay a spousal rollover, and not have to take an RMD for 6 more years.  This is true even if the surviving spouse is past their own RBD and must take RMDs for his or her own traditional IRAs.

The inherited IRA can always be rolled over just before RMDs start.^[5]  This is a significant incentive not to rollover right away, which is greater the younger the age of the deceased spouse.  For instance, if the deceased spouse died at the young age of 40, this special delayed RBD might be 35 more years until RMDs start (the applicable age will increase to age 75).

This scheme changes as of next year and will soon require an affirmative election for the surviving spouse to obtain the delayed RBD.

Spouses May Elect 10-Year Rule, Subject to Anti-Gaming Exception

Under the Proposed Regulations emanating from the SECURE Act issued last year, the IRS will now allow a surviving spouse to elect to use the 10-year rule if the deceased spouse/participant died before their RBD.^[6]  However, if the spouse tries to rollover before the 10th year, they will have to make up for what would have been their RMDs under the life expectancy rule, if any, minus what was actually taken.^[7]  Section 337’s new election scheme will effect this make up scheme as well, discussed further below.

Quick Recap of Unique Existing Rules and Paradigms for Retirement Accounts Payable to Conduit or Accumulation Trusts for Surviving Spouses

Many taxpayers are encouraged to ignore all the asset protection and state and federal estate tax advantages of leaving retirement assets in trust in favor of a spousal rollover, even for blended family situations where such a dispositive scheme may very well disinherit one side of the family from most of the couple’s wealth, because of the perceived (and sometimes actual) complexity of the planning, and higher RMDs for the surviving spouse if left in trust.

Remember, the SECURE Act changed the “stretch” rules for most beneficiaries, including trusts for surviving spouses.  A typical bypass or marital trust established for a spouse and then descendants would be (at best) an “accumulation trust”, subject to the 10-year rule in most cases (except perhaps accumulation trusts for disabled/chronically ill spouses, known as applicable multi-beneficiary trusts or “AMBTs”, or those with other eligible designated beneficiaries as the only other countable beneficiaries or remaindermen, but those would be rare and not be eligible for the benefit discussed herein).

Conduit trusts with the surviving spouse as the sole designated beneficiary, however, were largely unaffected by the SECURE Act.^[8]  Not only are they still considered as an eligible designated beneficiary (“EDB”), but they are still able to use the special delayed required beginning date rules permitted to sole beneficiary spouses discussed above.^[9]  Such conduit trusts are also subject to the new Section 327 regime.

Thus, the SECURE Act, while effectively killing the conduit trust design for many formerly common uses such as trusts for children or grandchildren, provided some incentive for attorneys to continue to use such provisions for surviving spouses.

SECURE Act 2.0 will turbo-charge this trend, by making the conduit trust even more attractive. Often derided as a “small beer” compromise between a discretionary trust and an outright bequest, conduit trusts are now more strongly encouraged by the combined effects of the original SECURE Act noted above, and SECURE Act 2.0, which now grants even more advantages to conduit trusts starting next year.  Namely, it will allow the use of the uniform lifetime table (or possibly even better), rather than the single life table used now once RMDs start.   If properly elected.

Current Special Provision for Inherited Retirement Accounts for Surviving Spouses Not Yet Rolled Over

Re-reading the current statute is helpful to compare and understand what the SECURE Act 2.0 amendment will be changing.  This is the current version:

IRC § 401(a)(9)(B)(iv) Special Rule For Surviving Spouse Of Employee—

If the designated beneficiary referred to in clause (iii)(I) is the surviving spouse of the employee—

IRC § 401(a)(9)(B)(iv)(I)—

the date on which the distributions are required to begin under clause (iii)(III) shall not be earlier than the date on which the employee would have attained age 72, and

IRC § 401(a)(9)(B)(iv)(II)—

if the surviving spouse dies before the distributions to such spouse begin, this subparagraph shall be applied as if the surviving spouse were the employee.

SECURE Act 2.0 Section 327 Changes to IRC § 401(a)(9)(B)(iv)

Now, for the new SECURE Act 2.0 changes.  In a nutshell, they will now require the surviving spouse to make an affirmative election to benefit from the delayed required beginning date (RBD), but if made, the result will be more advantageous than previously because the surviving spouse (or, more practically and importantly, a conduit trust for the surviving spouse) will be able to use the more advantageous uniform lifetime table and not the single life table that currently applies to such situations.  Here is the new Section 327 added by the SECURE Act 2.0 [bracketed comments in bold added by me to emphasize the changes to the existing statute]:

SEC. 327. SURVIVING SPOUSE ELECTION TO BE TREATED AS EMPLOYEE. (a) IN GENERAL.—Section 401(a)(9)(B)(iv), as amended by this Act, is further amended to read as follows:

• “(iv) SPECIAL RULE FOR SURVIVING SPOUSE OF EMPLOYEE. If the designated beneficiary referred to in clause (iii)(I) is the surviving spouse of the employee and the surviving spouse elects the treatment in this clause— [NB: Importantly, the election will now be required to get the delayed RBD benefit.  Further, the surviving spouse is the one who must make the election, even if the trustee of a conduit trust for them is the beneficiary.]
• “(I) the regulations referred to in clause (iii)(II) shall treat the surviving spouse as if the surviving spouse were the employee, [NB: (B)(iii)(II) is the stretch life expectancy rule that only applies to “eligible designated beneficiaries” now, i.e., it determines the amount of the RMD.  (B)(iii)(II) is not the clause that determines the RBD.  The RBD is determined by (B)(iii)(III), which is modified below.  This is easy to confuse and mistakenly conclude that a situation where a 73-year-old dies leaving an IRA to a 60-year-old means that the survivor will not have to start RMDs until reaching age 75, their RBD.  That is not the case (unless rolled over)]
• “(II) the date on which the distributions are required to begin under clause (iii)(III) shall not be earlier than the date on which the employee would have attained the applicable age, and [NB: Recall that 401(a)(9)(B)(iii)(III) referenced above basically states the general rule that RMDs are required not later than the year after the employee’s death (with exceptions for the five year rule, ten year rule if elected and of course this paragraph). SECURE Act 2.0, Section 107 replaces the RMD age 72 in the current version of the statute, which was age 70 ½ for many years, with the “applicable age” that increases from 72 to 73 and then eventually to age 75 in 2033.  Otherwise, this provision referencing (iii)(III) and delaying the required beginning date is very similar to the current version of Section 401(a)(9)(B)(iv)(I).]
• “(III) if the surviving spouse dies before the distributions to such spouse begin, this subparagraph shall be applied as if the surviving spouse is the employee. [NB: this sentence is identical to the current version of 401(a)(9)(B)(iv)(II) above, so no change to this aspect of the rule, other than only being relevant now if the election is made.]
• An election described in this clause shall be made at such time and in such manner as prescribed by the Secretary, shall include a timely notice to the plan administrator, and once made may not be revoked except with the consent of the Secretary.” [NB: this delayed RBD and new use of uniform lifetime table benefit requires an election!  The delayed RBD did not require any election before.]
• (b) EXTENSION OF ELECTION OF AT LEAST AS RAPIDLY RULE.—The Secretary shall amend Q&A -5(a) of Treasury Regulation section 1.401(a)(9)- 5 (or any successor regulation thereto) to provide that if the surviving spouse is the employee’s sole designated beneficiary and the spouse elects treatment under section 401(a)(9)(B)(iv), then the applicable distribution period for distribution calendar years after the distribution calendar year including the employee’s date of death is determined under the uniform lifetime table. [NB: this is a welcome change to current law and should always be more advantageous than using the single life table if the birth date of the surviving spouse used.  Congress likely goofed in referencing paragraph (a) of Q&A5 of the Reg though—it is more logical that they mean to amend paragraph (c)(2)]^[10]
• (c) EFFECTIVE DATE.—The amendments made by this section shall apply to calendar years beginning after December 31, 2023. [NB: no doubt they delayed the effective date a year so that the IRS and custodians can prepare for all the new election burdens]

COMMENT

Why the New Provision Will Actually Harm Many Surviving Spouses Who Are Named Primary Beneficiary

At first, just reading the title of the provision (SURVIVING SPOUSE ELECTION TO BE TREATED AS EMPLOYEE) and the portion about using the uniform lifetime table, you might be fooled into thinking that this new provision is greatly beneficial to many taxpayers who name their spouse as primary beneficiary, especially those cases where the younger spouse dies first, before their RBD.

You would be wrong.

The delayed RBD is now automatic through the end of this year.  Surviving spouses don’t have to do anything to get the delayed RBD, if they are eligible.  Starting next year, however, any surviving spouses (and their custodians and advisors) will have to be more diligent.

Would you rather receive a tax benefit automatically, or only if you file the right returns on time properly with the custodian and they store and report them to the IRS properly without any mistakes?  What happens when the surviving spouse moves the account to another custodian or consolidates an inherited IRA that makes an election with one that doesn’t ?^[11]

At least if surviving spouses and their custodians and advisors are on the ball, surviving spouses will now get this great new and improved benefit of being able to use the uniform lifetime table once RMDs start, right?

Wrong again.  Surviving spouses who inherit outright have always had the ability to do this via subsequent rollovers!  It’s not a great new benefit.

Remember in our hypothetical situation above of the 66-year old deceased spouse leaving assets to the 72-year old surviving spouse, the 72-year old would simply rollover into an IRA or plan in his or her own name before their RMDs start 7 years later (assuming the applicable age is age 73) and then be able to use the uniform lifetime table under current law (or they may get an even better deal if they marry someone more than 10 years younger).  So, this new feature of being able to use the uniform lifetime table with an election once RMDs start is really not much of a new benefit at all!

Unless we have a situation in which the spouse cannot rollover, such as a restricted trusteed IRA or conduit trust discussed in detail below (or maybe if there were a side marital agreement that precluded the ability to do a rollover somehow, but that would be quite rare and probably a bad idea).

The nutshell is that many spouses will lose the special delayed RBD starting next year because they simply miss making the election, a benefit that they would have received automatically had they inherited this year or earlier.  Perhaps Treasury will someday outline a process whereby spouses can spend tens of thousands of dollars in legal/accounting and PLR fees if they want to request relief for a missed election.

It’s not just situations where the younger spouse dies first that are affected.  Imagine a married couple, age 50 and 55, where the 55-year-old tragically dies.  Under current law, the survivor can just keep the funds as an inherited IRA for 9 years before rolling over until their own IRA (no election required).  Why delay?  Because this allows the survivor to access the funds without the 10% penalty that would apply if they tried to access such funds before age 59 ½ from an IRA in their own name.

What happens to this unfortunate couple if one dies next year when Section 327 changes are effective, and the survivor fails to properly and timely make the election?  If the surviving spouse does not make the proper election and does not take the appropriate RMD, you might think that they have to take the RMD and pay a 25%/10% penalty for failure to take the RMD, but might get that waived.^[12]

Not exactly.  There should be no penalty for failing to take an RMD in most cases due to a quirk in the deemed rollover rules.  But the effect may be worse!  When a surviving spouse inheriting an IRA outright does not take an RMD, it is deemed to be rolled over into his or her own name for tax purposes (whether it is for state law is another issue), but under the Proposed Regulations, only if is done by the later of when the surviving spouse turns 73 (age 75 eventually) or the year after the decedent’s death.^[13]

Thus, in our hypothetical above, our 50-year-old widow would be deemed to have rolled over her IRA once the RMD is missed. This means that any amounts taken before age 59 ½ will be subject to the 10% early withdrawal penalty unless an exception applies, even if the custodian still has the title to the account in the name of the deceased spouse as an inherited IRA for the survivor.  Unlike the former 50% now 25%/10% penalty which has heretofore very often been waived under a liberal statutory and regulatory scheme,^[14] this 10% early withdrawal penalty is rarely if ever waived and often subjects the taxpayer to accuracy-related penalties.  There is no sympathy for young widows trying to eke out a living from their late spouse’s IRA.^[15]  Moreover, it’s a one-way street.  A widow can later rollover an inherited IRA to his or her own, but they cannot do the opposite—undoing a rollover IRA back into an inherited IRA.  Even if the taxpayer were to spend a lot of money requesting relief and gets lucky, it’s much harder than getting toothpaste back into the tube.

Not only does this deemed rollover foreclose access to the account by the surviving spouse without incurring a nasty 10% penalty in our hypo, it may also foreclose the delayed RBD.  If the 50-year-old in our example above died first instead of the 55-year-old, and the election is missed and there is a deemed rollover, the survivor will have to take RMDs in 20 years (when the 55-year-old reaches age 75), rather than starting in 25 years when the younger deceased spouse would have reached the “applicable age”.

A deemed rollover might also muck up a surviving spouse’s back-door Roth conversion of their own IRA with basis due to the “cream in the coffee” rule that takes into account all of an owner’s IRAs, but not inherited IRAs.  For example, imagine a widow had made $12,000 in non-deductible contributions into her own traditional IRA and converted it into a Roth IRA when it is valued at $12,100.  She might think her income tax bill is only on $100 of gain because it was her only IRA, only to find out that her inherited IRA of 30 times that amount was deemed rolled over due to her missing the new election and her RMD, causing most of the Roth conversion to now be taxable income.

The lack of an election can even adversely affect situations in which the surviving spouse elects the 10-year rule instead of the standard “stretch” life expectancy payout.  As discussed in the paragraph on the new anti-gaming provision in the Proposed Regulations, there is a “claw back” of sorts, requiring RMDs to be made up to the extent the spouse would have had RMDs if they had been under the life expectancy payout. The RBD and RMD for surviving spouses may be affected starting next year depending on whether the new election is made.  Will the IRS allow both elections to be made?  Probably (the newest one is Congressionally mandated), and there may be some rare instances when a spouse will want to do this.

Imagine spouses age 68 and 70 and the 68-year old dies.  The surviving spouse elects the 10-year rule, perhaps due to highly fluctuating self-employment income and the ability to manage this better by taking no RMDs in high income years.  She takes no RMDs, but then decides to rollover 8 years from now.  The proposed regulations would force her to take the cumulative RMDs (calculated under the single life table, for now) that would have been due under the delayed RBD once her late spouse would have reached age 73 (the new RMD date in 2023), but starting next year, this treatment will be either better, or worse, depending on whether Section 327’s new election is made or not.  Starting next year, this delayed RBD will be unavailable unless the election is made, but if it’s made, not only will there be fewer RMDs due to the delayed RBD, but the make up RMDs will be smaller, due to using the uniform lifetime table.

Whose Life is it, Anyway?

Section 327(a) amends 401(a)(9)(B)(iv)(I) to provide that “(I) the regulations referred to in clause [401(a)(9)(B)] (iii)(II) “shall treat the surviving spouse as if the surviving spouse were the employee.” Section 401(a)(9)(B)(iii)(II) is the stretch life expectancy rule that only applies to “eligible designated beneficiaries” now, i.e., it determines the calculation of the RMD once they start.

Does this mean treating the surviving spouse as the actual employee (deceased participant), including using the deceased spouse’s date of birth?

Harkening back to our prior example of the 66-year-old deceased spouse leaving an IRA to a 72-year-old surviving spouse, assuming the surviving spouse makes the proper election, 7 years later when they do have to take RMDs under the uniform lifetime table, do they use their birth date or their late spouse’s later birth date to calculate the RMD?

In informal discussions with several prominent ACTEC attorneys, most of them have interpreted this provision to mean that the deceased spouse’s birth date should be used once RMD start.  I disagree with my illustrious colleagues, but I could certainly be wrong on this point.  I believe this provision means that the surviving spouse is treated as if they were the participant (employee) of the plan (or owner of the IRA) for purposes of calculating the RMD once it starts, which includes using the survivors date of birth.  This could theoretically even mean using joint and survivor tables if the surviving spouse remarries someone more than 10 years younger, but that is yet another uncertainty under the law.

If Congress had meant to change both what tables and whose birth date to use, Congress would have noted both of these new differences from the current regulatory scheme in Section 327(b)’s instruction to amend Treas. Reg. §1.401(a)(9)-5, Q&A5 so that “the applicable distribution period for distribution calendar years after the distribution calendar year including the employee’s date of death is determined under the uniform lifetime table.” Section 327(b) only instructed Treasury to change the table used, not the birth date used under the current Treas. Reg., which now uses the surviving spouse’s birth date. Congress made no mention in its instructions of the surviving spouse being able to use the joint and survivor table if they remarry someone more than 10 years younger, but that would seem to logically follow from the new provision treating the spouse as the employee.

Dusting Off the Joint Life and Last Survivor Expectancy Table

Whether the survivor’s or the decedent’s date of birth will be used with the uniform lifetime table, we know that the new RMD scheme for spousal inherited IRAs will at least be using the uniform lifetime table next year if the new election is made.  Many will note that the uniform lifetime table does not even have RMD divisors for anyone under age 72 currently.

Starting next year, of course, we’ll need the uniform lifetime table repopulated with younger possibilities, since it must be used under Section 327’s changes to 401(a)(9)(B)(iv) if the spouse makes the appropriate election and it’s necessary to find the RMD for a younger spouse as beneficiary.  This will not require any complicated research, just taking the numbers from the joint and survivor table for the applicable age and someone 10 years younger.  If you look up the divisors for a couple aged 72/62, 73/63, 74/64, etc. from the joint life table (Table II), you will see that they simply create the uniform life table (Table III), so finding younger ages for the uniform lifetime table just requires consulting the diagonally proceeding crosshairs of the rows and columns of the current joint life and last survivor expectancy table.

Why the New Section 327 Provision is a Boon to Using Conduit Trusts, but Creates More Issues for Drafting and Administering Them

Unlike surviving spouses in our hypotheticals noted above, trustees of conduit trusts cannot just roll over an inherited IRA into their own and start using the uniform lifetime table before RMDs start.  Thus, the benefit of the new election and being able to use a more favorable uniform lifetime table is much greater and has more upside potential for conduit trusts.

Under current law, a conduit trust for the surviving spouse as sole beneficiary must use the single life table, recalculated annually, but the trustee may with the election discussed herein, starting next year, use the uniform lifetime table, which is much more advantageous, especially for the increasing number of Roth accounts.

This drawback of using the single life table under current law is one of the reasons often cited to clients who would otherwise like to use trusts to protect their assets left for their spouse to convince them to name them as beneficiary directly.  Their accountant or financial advisor may say—”forget the asset protection or federal/state estate tax advantages of a trust, there will be much higher RMDs if you use a trust!”^[16]  This new provision largely mitigates this drawback to using conduit trusts.  The trust will now be using the same uniform lifetime RMD tables that the surviving spouse would likely use if they inherited outright, but the trust provides infinitely more protection for the current and remainder beneficiaries of the trust.

Despite the huge upside, the new provision adds complexity.

Not only does the trustee have to be on the ball in making sure the election is made, but if the trustee is different from the surviving spouse (which is often the case for blended family situations in which the settlor wants to protect some of the funds), the trustee must work with the surviving spouse, who is the party under the statute who must make the election.  What if the surviving spouse (or their guardian) is not cooperative?

There are many various solutions to this, but it does add more complexity to the estate planning.  For example, the trust instrument could make the trust completely discretionary (an accumulation trust) if the surviving spouse refuses to make the election, or it could sweeten the pot in other ways, such as granting the surviving spouse the right to demand other assets to make up the difference between what the RMD would be under the single life table and what the RMD would be under the uniform lifetime table if the election is made, or establish a unitrust.  Whether using a carrot or a stick or a combination thereof, creative practitioners can find many, many ways around this problem, but it all means going back to the estate plan to make more modifications that taxpayers will not be too crazy about.

What if the surviving spouse remarries someone more than 10 years younger?  If they are deemed to be the employee for RMD purposes, pursuant to new Treas. Reg. §1.401(a)(9)(B)(iv)(I), would they (the conduit trust) then be eligible for an even lower RMD?^[17]  Lowering the RMD may sound great to a settlor or trustee or their accountant wanting to minimize RMDs, but perhaps not so much to the surviving spouse.  As discussed above, it’s uncertain whether this would apply, but it seems to logically follow from new provision.  Would a trust instrument that does not otherwise make up for the lowered RMD with other distributions to make up the difference create an impermissible incentive that discourages remarriage and is therefore void as against public policy?^[18]

Take Heart—The New Complications in Drafting and Administering Conduit Trusts is Worse for Trusteed IRAs

IRAs can come in two legal forms: a trust, which is the first legal form mentioned in IRC § 408, or a custodial agreement.^[19]  99.9% of the time these two forms function exactly the same way, but there may be differences in the former allowing a trustee to manage both the account and the distributions for a needy beneficiary, and differences in administering the account post-mortem if the owner and trustee agree to administer the trust as an irrevocable conduit trust for the beneficiaries after death.  If the latter was done, SECURE Act 2.0 throws a wrench into planning.

For a while, trusteed IRAs with restrictive payout options (one that is not simply withdrawable by the beneficiary) mimicking a conduit trust looked to be a narrow but elegant solution and niche that might provide some advantages in economy, drafting and administration of larger IRA accounts.  However, as discussed above, the SECURE Act largely knee-capped the use of conduit trusts (and concurrently, trusteed IRAs), for all but a very narrow category of beneficiaries.

SECURE Act 2.0 further complicates their use for surviving spouses because it is more difficult to adapt trusteed IRAs.  Separate trusts are more easily amended during life and after death.  They often have internal amendment provisions, trust protector provisions or lifetime limited powers of appointment or decanting capabilities to make some of the tweaks suggested above to accommodate for the spouse’s required election under Section 327’s new scheme, such as compensating from other non-IRA assets if the surviving spouse makes the appropriate election.

By contrast, a Trusteed IRA agreement will rarely have such clauses, nor will it have access to other non-IRA funds to draw from to make up for a lowered RMD and delayed RBD.  Its ability to adapt is more limited and cumbersome and it can’t just become an accumulation trust if the spouse does not make the election.  A bank or trust company naturally wants uniformity in its forms and distribution clauses and cannot so easily accommodate many different changes in how to adapt to the new regime.

Overall Impact to Planning Much More than Other Secure Act 2.0 Changes

These Section 327 changes, seemingly innocuous and heretofore completely escaping notice among the financial, accounting and estate planning community, actually raise significant practical issues. It’s not uncommon at all for a younger spouse to die first before their RBD, and nearly half the population now consists of non-traditional blended families, for whom spousal trusts are often a practical estate planning solution (not just the ones with enough to worry about estate tax sheltering).

It is hard for many practitioners to keep up with these developments though (especially if they are not LISI subscribers).  The original SECURE Act already added layers of complexity on top of the older already complicated rules, and many of these are still not sorted out with any final regulations (some were not even addressed with the late-in-coming proposed regulations).  Now we have SECURE Act 2.0 to add more complexity on top of this, with added years of uncertainty as to what it all means.   I am not certain I have even caught all of the new issues raised by this new Section, much less others.

As with a lot of the SECURE Act changes, sometimes the complexity of becoming a “see through trust”, or obtaining the maximum “stretch” (which is not always the same), is simply not worth it.  It might be a huge benefit to have a delayed RBD with younger couples, but not at all for older ones.  It might be a huge benefit to get a “stretch” rather than the 5- or 10-year or ghost life expectancy rule in some cases, but certainly not in others (and sometimes, it’s the opposite).  Trust provisions regarding retirement plans that work great for a couple in their 40s may not work well for a couple in their mid-70s or 80s and vice versa – and that’s not even counting the potential for further changes in tax law!  This makes a “one plan fits all” quite impossible (or foolhardy), and difficult to explain to clients with short attention plans for parsing through IRC Section 401(a)(9)(B)(iv)(whatever).

Final Plea to Congress

I am not aware of any industry group or lobbyists that were pushing for this change.  Why make an additional benefit intended for widows and widowers contingent on an election at all?  Just give them the benefit and be done with it!  An election is just one more hassle and expense for trustees and custodians, area for advisor training (and malpractice), stress for widows and widowers, and even extra training and expense for the IRS to track and process. It’s like a car company making their great new seat belts and airbags optional, but only if you read all the fine print and ask for it on time on the proper form (with their generously deigning to consider allowing you to install the option late if you hire an attorney and accountant for a $20,000 retainer, pay a $38,000 filing fee and wait 6-9 months…)

CITE AS:

LISI Estate Planning Newsletter #3010 (January 24, 2023) at http://www.leimbergservices.com. Copyright 2023 Edwin P. Morrow III. Reproduction in Any Form or Forwarding to Any Person Prohibited – Without Express Permission. This newsletter is designed to provide accurate and authoritative information regarding the subject matter covered. It is provided with the understanding that LISI is not engaged in rendering legal, accounting, or other professional advice or services. If such advice is required, the services of a competent professional should be sought. Statements of fact or opinion are the responsibility of the authors and do not represent an opinion on the part of the officers or staff of LISI.

CITES:

Consolidated Appropriations Act, 2023.  Division T of the Act Contains the SECURE Act 2.0 of 2022.  For life expectancy tables discussed herein, see IRS Publication 590-B at https://www.irs.gov/publications/p590b, which includes Table I (Single Life Table), Table II (Joint Life and Last Survivor Expectancy Table) and Table III (Uniform Lifetime Table).

CITATIONS:

^[1] The text of the new changes and the link to the entire bill is here (skip to Section 327 of the bill, pages 901-902, for the amendment discussed in this newsletter).  If you hope to glean some understanding from reading a summary of the bill, which sometimes describes the main intention of a provision, instead of the actual text, you will be disappointed.  Here is the summary description:

Section 327, Surviving spouse election to be treated as employee. Section 327 allows a surviving spouse to elect to be treated as the deceased employee for purposes of the required minimum distribution rules. Section 327 is effective for calendar years beginning after December 31, 2023

^[2] See the Joint Committee of Taxation’s ESTIMATED REVENUE EFFECTS OF H.R. 2617, JCX-21-22 (December 22, 2022) which outlines the annual cost for the ten years after passage (no effect in 2023 since the effective date is 2024), totaling the next nine year’s cost to the Treasury (and net benefit to taxpayers), as follows:

“27. Surviving spouse election to be treated as employee,…-1,101” [in millions]

^[3] The relevant age was recently, of course, age 70 ½, then age 72. Section 107 of the SECURE Act 2.0 extends this RMD age to age 73 and eventually in 2033, age 75.  See the link in the above endnote.

^[4] IRC § 402(e)(4).

^[5] Treas. Reg. §1.408-8, A5(b).  Proposed regulations will add a new deadline for a spouse to treat an inherited IRA as one’s own, however, if made final.  See Prop. Reg. §1.408-8(c).

^[6] Prop. Reg. §1.401(a)(9)-3(c)(5).

^[7] Prop. Reg. §1.402(c)-2(j)(3)(iii).

^[8] See Treas. Reg. §1.401(a)(9)-5, A7(c)(3), Example 2 and Prop. Reg. §1.401(a)(9)-4(f)(1)(ii) for definition and description of these terms.

^[9] Conduit trusts that qualify for the marital deduction (e.g., make the QTIP election), have an additional requirement to either mandate the payment of the accounting income from the IRA/plan, or permit the surviving spouse to withdraw it.  Rev. Rul. 2006-26.  This is true even if when is no RMD, which may occur under the 5- or 10-year rule or when the trust qualifies as an EDB with the special spousal delayed RBD discussed herein.  Most trusts mandate that such income be paid out (whether they actually do in practice or not is another issue), when such a distribution out of the plan/IRA is not required to qualify, which reduces the stretch unnecessarily and perhaps at times unwisely, especially when unrequired Roth IRA distributions are involved.  The trust could, of course, merely permit the spouse to access such non-RMD income.  For a younger surviving spouse with a Roth IRA, the difference may be quite significant.

^[10] Treas. Reg. §1.401(a)(9)-5, Q&A5 paragraph (a) only concerns deaths on or after the RBD, paragraph (b) concerns deaths after the RBD and only paragraph (c)(2) concerns the special rule for surviving spouses.

^[11] Treas. Reg. §1.401(a)(9)-8, Q&A1 for merging inherited IRAs from the same decedent and Treas. Reg. §1.403(b)-3, Q&A4 for merging 403(b)s.  It remains to be seen whether you can even make the election for one account (or plan type) and not the other!  Add these issues to the list of uncertainties.

^[12] Section 302 of the SECURE Act 2.0 reduces the 50% excise tax under IRC §4974 to 25% starting in 2023 and adds a new provision whereby timely corrections may even reduce this penalty to 10% in some cases.

^[13] Treas. Reg. §1.408-8, A5(b):

“Alternatively, a surviving spouse eligible to make the election is deemed to have made the election if, at any time, either of the following occurs –

(1) Any amount in the IRA that would be required to be distributed to the surviving spouse as beneficiary under section 401(a)(9)(B) is not distributed within the time period required under section 401(a)(9)(B); or”

^[14] IRC §4974(d) “Waiver of tax in certain cases

If the taxpayer establishes to the satisfaction of the Secretary that—

(1) the shortfall described in subsection (a) in the amount distributed during any taxable year was due to reasonable error, and

(2) reasonable steps are being taken to remedy the shortfall,

the Secretary may waive the tax imposed by subsection (a) for the taxable year.”

Section 302 of the SECURE Act 2.0, effective this year, changes the penalty scheme from 50% to 25% or sometimes 10%, but does not amend §4974(d), which liberally allows Treasury to grant waivers, which is quite common.  IRC §72(t), that sets out the 10% additional tax (early withdrawal penalty), notably, has no equivalent paragraph.

^[15] See, e.g., Atkin v. Comm., T.C. Memo 2008-93 (no waiver, plus accuracy penalty).  There are too many general 10% early withdrawal penalty cases to bother citing, but here are a couple with just this exact situation involving unsuspecting widows in situations such as described: Sears v. Comm, T.C. Memo 2010-146 (widow under age 59 ½ hit with 10% additional tax for taking distributions from late husband’s rolled over IRA), Charlotte and Charles T. Gee v. Comm.,127 T.C. 1 (2006) (widow under age 59 ½ hit with 10% tax for taking from late husband’s rolled over IRA).

Although we colloquially call the 10% tax a “penalty”, it’s technically an additional tax rather than a penalty, which can be worse in some cases.  See e.g., Grajales v. Comm., 156 T.C. No. 3 (2021).

^[16] It’s common to hear that a conduit trust will completely drain the trust and lose all the protections of the trust if the surviving spouse lives to their life expectancy. This is untrue.  The reason conduit trust provisions will not cause a trust for a spouse to be depleted as fast as feared is that the RMD divisor is recalculated annually rather than reduced by 1 every year.  If the divisor is 18 for an ordinary eligible designated beneficiary (EDB), it will truly be gone in 18 years (1/18, 1/17, etc.), whereas if a surviving spouse is the sole eligible designated beneficiary (SSSEDB?), the divisor will be reduced by less than one every year (e.g., 1/18, 1.17.3, 1/16.5 etc.), extending the “stretch”. However, the current paradigm is not nearly as advantageous as the new scheme starting next year using the more favorable uniform lifetime table—if the proper election is made!

^[17] Treas. Reg. § 1.401(a)(9)-5, A4(b).  Did I mention the additional compliance problems and tax traps if the surviving spouse then divorces without informing the custodian or trustee and modifying the RMD schedule the next year?  See paragraph (b)(2) of the above reg.

^[18] See, e.g., Restatement of Trusts, 3d, §29.

^[19] See Trusteed IRAs: An Elegant Estate Planning Option, Trusts and Estates, March 2009, Contrasting Conduit Trusts, Accumulation Trusts and Trusteed IRAs, Morrow, J. Retirement Planning, June 2007, Life and Death Planning for Retirement Benefits, 7th Ed., Choate, ¶6.1.07

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ABOUT THE AUTHOR

Edwin P. Morrow, III, J.D., LL.M., MBA, CFP®, CM&AA® is a Wealth Strategist for Huntington National Bank, where he concentrates on thought leadership and planning ideas for high net worth clientele in tax, asset protection and estate planning areas.  Ed was previously in private law practice working in taxation, probate, estate and business planning. Other experience includes research and writing of legal memoranda for the U.S. District Court of Portland, Oregon as a law clerk. He is a Fellow of the American College of Trust and Estate Counsel (ACTEC). He is a Board Certified Specialist (through the Ohio State Bar Assn) in Estate Planning, Trust and Probate Law, a Certified Financial Planner (CFP) professional and a Certified Merger & Acquisition Advisor (CM&AA). He is also a Non-Public Arbitrator for the Financial Industry Regulatory Authority (FINRA) and a member of the Editorial Advisory Board of the Probate Law Journal of Ohio.  Ed is a frequent speaker at CLE/CPE courses on asset protection, tax and financial and estate planning topics, and recently co-authored, with Stephan Leimberg, Paul Hood, Martin Shenkman and Jay Katz, the 18th Edition of The Tools and Techniques of Estate Planning, a 997-page practice-based resource on estate planning.