Estate Planning Series Part 8: What is the impact of the SECURE Act of 2019 on retirement plan beneficiaries?
What is the SECURE Act?
More than a year has passed since the Setting Every Community Up for Retirement Enhancement Act (SECURE) passed Congress by a wide margin. The Act made a major change for IRA beneficiaries. Prior to the Act, someone who inherited an IRA could implement a "stretch" strategy in which the beneficiary leverages the IRA's tax deferral by taking no more than required minimum distributions (RMDs) for a number of years. That allows the IRA's value to grow over time, increasing the after tax wealth eventually liable to the beneficiary.
How did the SECURE Act impact IRAs?
The SECURE Act abolished the stretch IRA for most beneficiaries. In most cases, the inherited IRA must be fully distributed within 10 years after the original owner passed away. The beneficiary can distribute the IRA on any schedule but the IRA must be fully distributed by the end of 10 years. The SECURE Act applies to both traditional IRAs and Roth IRAs. Though a distribution from a Roth IRA isn't taxable, Congress still requires that the IRA be distributed within 10 years, perhaps with the policy that distributions will be put into taxable investments and generate more revenue for the government. The SECURE Act also applies to 401(k)s and other defined contribution accounts.
Exceptions to the 10 year rule.
1. Pre-2020 beneficiaries. The 10 year rule applies only when the original owner of the IRA passed away after 2019. Beneficiaries who inherited IRAs before 2020 are grandfathered, which means they follow the old rules and continue to benefit from a stretch IRA. Someone who became an IRA beneficiary before 2020 was usually able to take RMDs from the inherited IRA based on life expectancy. Anyone in that situation can continue the same RMD schedule that was in effect before the SECURE Act was enacted. The pre-2020 IRA beneficiary also has the option to take a distribution of more than the RMD at any time. The beneficiary must be what the Internal Revenue Code calls a designated beneficiary and only individuals can be a designated beneficiary. An IRA doesn't have a designated beneficiary when no beneficiary is named or the estate or trust is named. A charity, corporation, or other entity does not qualify as a designated beneficiary.
2. Where the beneficiary of the IRA is other than an individual. For these IRAs the required distribution schedule depends on whether the IRA owner died before or after reaching the required beginning date for RMDs. For those who turned 70 1/2 in 2020 or later, the required beginning date is 72. For all others the required beginning date is 70 1/2. When the IRA owner dies before the required beginning date, the five year rule applies. The entire IRA must be distributed within five years. When the IRA owner died after the required beginning date, the IRA can be distributed as thought the IRA owner still lives, using the owner's remaining life expectancy in the IRS's life expectancy tables. The IRA can be distributed faster than required.
3. Surviving spouse as beneficiary. Surviving spouses who are IRA beneficiaries are excluded from the 10 year rule. One option of the surviving spouse is to roll over the IRA to an IRA in the surviving spouse's name. This can either be a new IRA or an existing IRA. This is known as a "fresh start" IRA because the surviving spouse can treat the IRA as though it always had been his or her IRA without reference to the IRA of the deceased spouse. Another option for the surviving spouse is to treat the IRA as a regular inherited IRA. The difference is that after the SECURE Act the surviving spouse isn't subject to the 10 year rule. The surviving spouse of an inherited IRA uses the old rules, which allow for a stretch IRA with RMDs taken over the surviving spouse's life expectancy.
Eligible designated beneficiaries.
A new category of beneficiary after the SECURE Act is the eligible designated beneficiary (EDB). An EDB is a beneficiary who is exempt form the 10 year rule. A surviving spouse is an EDB. Other EDBs are a minor child of the deceased IRA owner, a disabled or chronically ill beneficiary and a beneficiary who is not more than 10 years younger than the deceased IRA owner.
Note that while a minor child is an EDB, a grandchild is not. A minor child is only an EDB for as long as she or he is under the age of majority, which in Wyoming is 18. Once the beneficiary reaches the age of majority the 10 year clock starts running.
Estate planning for IRAs completely changed after 2019. Be sure to name the right beneficiaries and that your beneficiaries receive good advice.
The next Estate Planning Series, Part 9, will address changes in the way title to property should be designated.