Client Service September 20, 2019

Inheritance Pathways Exist to Replace Stretch IRAs

The SECURE Act is stalled in the U.S. Senate due in part to several lawmakers’ concerns that it does away with so-called “stretch IRAs,” but tax and inheritance experts say other effective tax mitigation strategies are available.
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Art by Lily Padula


Low and middle-income Americans struggling to save for retirement are depending on the U.S. Senate to pass the SECURE Act, advocates say, but one roadblock is the law’s treatment of “stretch IRAs.”

The term “stretch IRA” refers to an estate planning strategy that involves either a Roth or a traditional individual retirement account (IRA)—it is not a special type of IRA. By “stretching” the IRA, individuals can preserve their retirement account’s tax-deferred status and allow its continued use by future beneficiaries.

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In his practice as an estate and trust principal at the accounting and tax advisory firm Kaufman Rossin, Scott Goldberger spends a lot of time collaborating with his clients’ retirement and wealth management advisers. He says the SECURE Act has come up quite often in recent conversations and planning sessions, as do the tax cuts passed by the previous Republican-controlled Congress.

“Every time there is change in the tax laws we spend a lot of time digesting what it means for clients,” Goldberger says. “In thinking about wealth for families and estates and trusts, the biggest change we’re dealing with in the tax overhaul is the doubling of the estate tax exemption. Practically speaking, for a lot of our clients this environment means we have to take something of a wait and see approach.”

Goldberger says he and his retirement plan adviser colleagues are following the SECURE Act closely.

“Whether a client’s tax-qualified assets are a significant or insignificant portion of their overall wealth, passage of the SECURE Act would be meaningful to them in some way,” Goldberger says. “From my perspective focusing on taxation and inheritance, the most significant development in the SECURE Act is the treatment of stretch IRAs. In short, the bill would impose a 10-year period after which the stretched IRA would have to be distributed in full to the beneficiary, rather allowing the required minimum distributions to be taken out over the beneficiary’s lifetime.”

The Problem with SECURE

Goldberger suggests this development would curb clients’ ability to use IRAs to defer income tax as long as possible, and it would also put in doubt some of the estate planning that clients may have previously done in organizing IRA trusts.

“Depending on the kinds of trust they were planning on using—it may or may not continue to be a good idea after the passage of the SECURE Act,” Goldberger warns. “Specifically, I’m talking about whether they have chosen to utilize for their beneficiaries a so-called conduit trust versus an accumulation trust.”

In very simple terms, the conduit trust is a variety of IRA trust whereby any required minimum distribution (RMD) that is paid by the retirement account to the trust is directly distributed to the beneficiary—hence the use of the term “conduit.” In Goldberger’s assessment, conduit trusts made great sense when a beneficiary had a time horizon for distributions of potentially many decades, as would be the case when a young person was named as the beneficiary under current law.

“But under SECURE, at the end of the 10-year deferral period, the entire retirement account would end up having to be distributed to the beneficiary outright,” Goldberger says. “That could be disastrous if you are trying to protect those funds for the beneficiary longer-term, especially if the beneficiary has creditor issues or divorce issues.”

In highlighting this concern, Goldberger points out that the issue can potentially be dealt with relatively easily.

“I believe this distribution issue can actually be dealt with pretty easily by using an accumulation trust as opposed to the conduit trust,” he explains. “With the accumulation trust, although the trust is getting the required minimum distributions and eventually a lump sum distribution after 10 years, the trustee is not required to then turn around and immediately pass the distributions on to the beneficiary.”

Instead, as the name indicates, the trustee can accumulate those funds within the trust for the long-term benefit of the beneficiary.

“So, even if the SECURE Act passes and we have a 10-year payout period, at the end of that period, the funds of the retirement account simply go into the trust account, where they continue to be protected for the beneficiary,” Goldberger says. “For those individuals who would have conduit trusts created under the terms of their wills or who have already created revocable trusts of this type, there is an easy fix. It is simply to amend the documents to create an accumulation trust as opposed to a conduit trust.”

Goldberger notes that other forms of “stretching” are possible beyond the use of accumulation trusts. As a prime example, he points to the linking of an IRA to “charitable remainder trusts.”

“This strategy has been around for a long time,” he says. “Simply put, the individual puts assets into the charitable remainder trust, names a beneficiary of his choosing, and then defines a payment schedule out of the trust for the beneficiary’s lifetime or for a set period of years.”

The beneficiary receives a taxable payment each year from the trust, but the wealth can continue to grow income tax-free within the trust over time. At the end of the term of years or at the end of the beneficiary’s lifetime, whatever is left in the trust is passed on to one or more charities of the choosing of the person who created the trust.

“It’s interesting to revisit this already popular strategy in the context of the SECURE Act, because, if restrictions are put on stretch IRAs and the client has an interest in charity, then they can set up one of these charitable remainder trusts that can serve as a sort of quasi-stretch IRA,” Goldberger says.

Other Concerns to Consider

Lisa Schneider, leader of the trust and estates practice at the law firm Gunster, agrees that the SECURE Act would cause some significant disruption for her clients’ estate plans.

“The SECURE Act is very important even for our very wealthy clients who have significant assets outside the retirement plan context,” Schneider says. “Many of them also have significant retirement plan assets—especially a lot of the clients who were executives. They may have a lot of wealth in their retirement plans, and the SECURE Act in my view totally changes how this group views and addresses their tax-deferred retirement plan assets.”

Schneider expects her clients would face significantly higher taxes under the inheritance regime that would be established by the SECURE Act, to the tune of a collective $16 billion more per year across the U.S.

“The stretch IRA for all intents and purposes disappears with the Act,” she says. “You have the exceptions for surviving spouses, minor children and persons with disabilities. But otherwise it’s going to have a dramatic impact from a marginal tax rate perspective. Most people would have to draw the income over a 10-year term.”

When it comes to the opportunities presented by the SECURE Act’s exceptions to the 10-year draw down, Schneider says, these may prove to be more limited than some expect. 

“The problem with putting the money in trust is that under the SECURE Act as drafted, it appears that you have to look at both the initial beneficiary and the second-tier beneficiary, as well, to determine whether the structure of the trust will be excepted from the 10-year rule,” she explains. “What I mean is that, if you set up the trust initially for a spouse or a minor child, but your second tier beneficiaries are your adult children, you now don’t have that exception at every level. In my opinion it is unclear in this situation if the trust falls within the SECURE Act’s exception. This would need to be clarified in the Act itself or in the regulations that would be promulgated thereunder.”

With charitable remainder trusts, Schneider agrees this will be one option to look at.

“It’s a way of basically drawing money out longer than the 10 years, because you can spread out the benefit of the IRA over a defined period of years or a person’s lifetime,” she says. “But at the end it does go to charity, so it’s going to be a specific type of client that is interested in this.”

Individuals may also consider doing a Roth IRA conversion, Schneider suggests. The client in this situation pays the tax up front, rather than seeing the taxation occur post-mortem.

“One caveat is that you don’t want to pay the tax from within the IRA you are converting, because that defeats the whole purpose of this strategy,” she explains. “Instead, you need to have liquid assets outside the IRA to pay the taxes, and that allows the IRA to remain intact and to grow tax-free for the duration of whatever inheritance strategy you ultimately put in place. In order for the conversion to make sense in most instances, you have to have the liquidity to pay the tax. If your liquid wealth is tied up in the IRA, in business or real estate, this may not be a great approach.”

Compliance September 13, 2019

Is Mandatory Arbitration Likelier for ERISA Complaints?

The Dorman vs. Charles Schwab Corp. decision out of the 9th Circuit is significant, but it leaves at least one “glaring unresolved question,” attorneys say.
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Art by Claudi Kessels


The 9th U.S. Circuit Court of Appeals in August issued an important ruling in Dorman vs. Charles Schwab Corp.

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In short, the appellate court decision stated that Schwab could enforce its retirement plan’s arbitration clause requiring participants to file individual claims and to waive class-action claims. Legal experts say the case raises questions that should give plan advisers pause before recommending that their sponsor clients include an arbitration clause in their plan.

The court ruled that the plan expressly said all Employee Retirement Income Security Act (ERISA) claims should be individually arbitrated and that the plan also included a waiver of class action suits. Dorman’s original suit accused Schwab of breaching its fiduciary duties by including poorly performing Schwab-affiliated funds in the plan. He brought the suit on his own, seeking class-action remedy for the plan in its entirety.

The 9th Circuit’s decision is “significant because it is the first case in the nation to explicitly permit the implementation of an arbitration provision in a plan document,” says Nancy Ross, a partner at Mayer Brown in Chicago. “However, the ramifications of this are still very much uncertain.”

First and foremost, the decision was made by a three-judge panel, and it is very unusual for a circuit panel to overturn an earlier full circuit decision, Ross says. In this case, the panel overturned the 9th Circuit’s 1984 position in Amaro v. Continental Can Co. that lawsuits filed under ERISA cannot be arbitrated. The panel reasoned that in the 35 years since that time, the Supreme Court has ruled that arbitration panels do have the necessary expertise to hear ERISA breach claims.

Secondly, Ross says, Dorman has asked for the full court to conduct an en banc review of the case, which could in the end fundamentally change the decision. Thirdly, she adds, should the full court uphold the panel’s decision, it would still only apply to the 9th Circuit, which includes Alaska, Arizona, California, Hawaii, Idaho, Montana, Nevada, Oregon and Washington.

Joan Neri, counsel in Drinker, Biddle & Reath’s ERISA practice in Florham Park, New Jersey, says the case “does not address how a fiduciary breach claim seeking plan-wide relief aligns with the individual recovery sought in arbitration. This is something that advisers and sponsors should continue to watch in the litigation sphere before making any amendments to a plan.”

Neri further explains, “The 9th Circuit in Dorman focused on whether the plan or the individual had agreed to the arbitration. Because the arbitration provision was in the plan, the court concluded that the plan had expressly agreed that the ERISA claim could be arbitrated. This was a factor that distinguished this decision from the 9th Circuit’s earlier decision in Munro v. University of Southern California in which the arbitration agreement was signed by the individual as part of her employment agreement.”

What Dorman did not address was “how the relief provided in an individual arbitration, i.e. the participant’s individual damages, reconciles with the plan-wide relief for the breach of fiduciary claim,” Neri says. “That is the glaring unresolved issue. Can individual arbitration of fiduciary breach claims be forced by a plan? Until this issue is resolved, I am not rushing out to encourage my plan sponsor clients to adopt mandatory arbitration provisions for fiduciary breach claims.”

While, “generally, plan sponsors prefer arbitration to going to court,” there are some downsides to arbitration, notes Tad Devlin, a partner with Kaufman Dolowich & Voluck in San Francisco. “For non-experienced practitioners, the ERISA statute can be a labyrinth, so this would weigh some plan sponsors in favor of going before a federal judge who has heard these types of claims,” he says.

“Another disadvantage to arbitration is that it is confined to a limited review, and the arbitration award likely would be final and binding and can be very difficult to challenge or overturn,” Devlin continues. “It can be almost impossible to challenge at the judicial level on a petition to vacate the award. To do so, the sponsor would essentially have to show the award decision was fraudulent or corrupt. On the other hand, in a judicial setting, you have at your disposal the district court, the court of appeals and the highest court in the land.”

Ross adds that should a plan sponsor go the arbitration route to try to avoid class-action lawsuits, those could lead to “thousands of individual arbitrations, and some of these decisions could be inconsistent with one another. So, while on the surface the Dorman decision seems like a tremendous panacea for class-actions, that is not necessarily the case.”

Nonetheless, should a plan sponsor decide it wants to include an arbitration clause in its plan document, Neri recommends “it follow the Dorman approach, namely, it should require that the claims  be arbitrated on an individual basis rather than a class-action basis, and it should include a class-action waiver.”

Devlin says sponsors should go a step further by having “all participants specifically sign off and acknowledge the arbitration provision, rather than have a claimant contend the arbitration provision language was somehow not reviewed because it was included in a 25-page document. Make sure all participants are fully versed on the clause’s provisions, have them acknowledge that and send back to the sponsor a receipt that they agree to the language.”

As to whether or not the Dorman case could possibly reach the Supreme Court, Neri says that other circuit courts would have to reach a contradictory opinion on the case for that to happen, but that it is possible. “If other circuit courts disagree with the 9th Circuit’s Dorman decision, then appeal to the Supreme Court is likely. Given the differing interpretations of LaRue, the Supreme Court may take up this issue.”

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