Secure 2.0 Fixes Flaw in Special Needs-See Through Trust Planning (Mostly)

Congress recently passed the Secure 2.0 Act of 2022 as part of its 1,653-page consolidated spending bill, which became law 12/29/2022.?Secure Act 2.0 is a follow up, of course, to the SECURE Act passed in late 2019, and provides some moderate tweaks and improvements to encourage retirement savings.?One provision fixes an unfortunate quirk in the Secure Act that prevented certain special needs trusts (curiously referred to as "Applicable Multi-Beneficiary Trusts, or by their acronym, "AMBTs") from qualifying for the stretch out generally permitted to disabled or chronically ill beneficiaries if the trust named a charity to receive a portion of the trust assets after the disabled or chronically ill beneficiary's death. Unfortunately for those families where the owner died in 2020-2021, this fix only applies starting in 2023 and does not help any situations in which the retirement plan owners had died in prior years after the Secure Act's effective date.

The special provisions for applicable multi-beneficiary trusts are unnecessarily complex, hard to understand, confuse many practitioners and still require clarification from the Treasury Department, but the nutshell is that if someone leaves retirement plan benefits to a trust that only benefits qualifying chronically ill/disabled beneficiaries during their lifetime, the trust can accumulate distributions (referred to as an "accumulation trust") and still qualify to use the old "stretch" distribution scheme, paying out required minimum distributions (RMDs) over the disabled/chronically ill beneficiary's life expectancy. This is often much better than the 10-year rule applicable to most situations, and much better than the 5-year rule or "ghost life expectancy" rule applicable when a trust as beneficiary does not qualify as a see through trust at all.

Under the initial iteration of the Secure Act 2.0 (and still the law for deaths in 2020-2021 where the beneficiary designation date and determination of what rules apply to the beneficiary would have already been determined), leaving even a dollar to charity when the disabled beneficiary dies completely disqualifies the trust from being an AMBT. Congress changed this in Section 337 of the Secure 2.0 Act and such trusts can now (starting in 2023) be AMBTs (the subcategory of see-through accumulation trusts for disabled/chronically ill) even if a charity receives a portion or all of the retirement benefits upon the death of the disabled/chronically ill beneficiary.

Mostly. There is still a "gotcha" that will trip up many families and practitioners. Congress doesn't just allow any charity. That would be too simple and not create enough exceptions and inadvertent disqualifications. The Secure 2.0 SNT/AMBT fix references IRC Section 408(d)(8)(B)(i), which is, for those not familiar, the Qualified Charitable Distribution ("QCD") section of the Code. Remember that you can't just name a donor advised fund (DAF) with your local community foundation as a QCD beneficiary, or most private foundations. DAFs are a favored option for many families, because it allows the family to allocate (or re-allocate) funds to the charities making the most impact on the favored cause (often associated with aiding the disabled/chronically ill beneficiary). But, if you name a DAF as a beneficiary of a dollar of the trust at the disabled/chronically ill beneficiary's death, so sorry, you lose the stretch and have to take those funds out much quicker (often over 5 years) at highly compressed tax rates.

What if there is a clause (which would not be uncommon) allowing the family or a trustee/trust protector to change the remainder charity to such an organization? Would this disqualify the AMBT ab initio, or have a retroactive effect only later if such a change occurs? We have no specific guidance of course, but in similar situations where a named public charity as initial beneficiary can be changed to a private foundation, for example, the IRS sees this as exactly the same as naming a private foundation from the outset! See Rev. Rul. 79-368. Oops! So sorry counselor that your attempt at reasonable flexibility cost the family thousands of dollars in additional income tax. Practitioners will have to be careful to limit such flexibility to only charities qualifying under IRC Section 408(d)(8)(B)(i).

At least if the power is held by a fiduciary, such as a spray power held by a trustee. Recall that the Proposed Regulations under the Secure Act do not count a potential appointee of a non-fiduciary limited power of appointment as a beneficiary when identifying all the designated beneficiaries of a trust. Potential appointees do not have any standing to contest trust matters as a general rule - discretionary beneficiaries do. Thus, if the family wants to be able to change the remaindermen of an AMBT to a private foundation or donor advised fund, they should make sure that this power is held by a non-fiduciary, such as a family member or trust protector (being careful to examine under state law and the trust instrument whether such a person is a fiduciary).

This is mostly a welcome fix from Congress, but it could have been much better thought out with fewer "gotchas" (both the initial law and the "fix"). Why penalize families who often want to secondarily help the charities that are helping their disabled/chronically ill family members or help cure or mitigate the respective illnesses affecting them? It's especially unfair for families who spent thousands of dollars effectively planning, drafting and executing such trusts for their family members based on prior law who were sandbagged by the Secure Act. Congress should have provided the same relief for families where someone died in 2020-2021 under the first Secure Act rules, and not just fixed it moving forward, and not tried to penalize families using their local community foundation's donor advised funds or supporting organization.

SEC. 337. MODIFICATION OF REQUIRED MINIMUM DISTRIBUTION RULES FOR 
      SPECIAL NEEDS TRUSTS.
    (a) In General.--Section 401(a)(9)(H)(iv)(II) is amended by 
striking ``no individual'' and inserting ``no beneficiary''.
    (b) Conforming Amendment.--Section 401(a)(9)(H)(v) is amended by 
adding at the end the following flush sentence:
            ``For purposes of the preceding sentence, in the case of a 
            trust the terms of which are described in clause (iv)(II), 
            any beneficiary which is an organization described in 
            section 408(d)(8)(B)(i) shall be treated as a designated 
            beneficiary described in subclause (II).''.
    (c) Effective Date.--The amendments made by this section shall 
apply to calendar years beginning after the date of the enactment of 
this Act.