How Do the SECURE Act and QDOTs Impact Retirement Assets Intended for a Non-U.S. Citizen Surviving Spouse?

Company News | Ladidas Lumpkins | Apr 17, 2020

The SECURE Act, enacted in December 2019, changed the Required Minimum Distribution (RMD) guidelines for IRAs. Most beneficiaries must now take full distribution of an IRA within 10 years of the owner’s death. Beneficiaries who can still “stretch” RMDs over their own lifetime are disabled individuals and the spouse of the deceased. That includes non-U.S. citizen surviving spouses. That’s the good news for non-U.S. citizen spouses. Now the bad:

A U.S. person may be subject to estate tax of up to 40% of the fair market value of their worldwide assets that are unsheltered by the estate tax exemption (currently USD $11.58 million per individual, and $23.16 million for a couple).

Unlike U.S. citizen spouses, transfers to non-U.S. citizen spouses do not qualify for the “unlimited marital deduction” that reduces the decedent’s taxable estate and defers both federal and gift tax on transfers of property between spouses, including IRAs.  That is, unless that property is held in a Qualified Domestic Trust, or QDOT.

The central purpose of a QDOT is to defer federal estate tax when a U.S. citizen dies and leaves substantial assets to a non-U.S. citizen spouse. A QDOT, which can hold all assets of an estate, can be established under a decedent’s will, as well as after his or her death by the surviving spouse if certain statutorily prescribed conditions are met.  Additionally, at least one of the QDOT’s trustees must be a U.S. citizen and/or a domestic U.S. corporation, and the terms of the QDOT must provide that the surviving spouse is entitled to all trust income during his or her lifetime.

So, for surviving non-U.S. citizen spouses, a QDOT defers the estate tax.  The income distributed to the surviving spouse, including RMDs from IRAs, is taxed at a top personal income tax rate of 37%.  One final caveat:

Distributions of QDOT principal, unless for hardship, are subject to estate tax.  This can occur if the RMDs that flow from the QDOT to the surviving spouse exceed IRA income.