New changes in the IRA landscape have recently occurred. In order to help you understand them, Sun Health Foundation has provided up-to-date information from Dave Eastman, estate planning attorney and partner at Morris Hall, PLLC, in Surprise, Arizona. In this article, we’ll cover the facts behind the SECURE Act and information about eligible beneficiaries.
Part 1: The Facts
In December 2019, Congress altered the IRA landscape yet again by passing the SECURE Act (Setting Every Community Up for Retirement Enhancement Act). Like all legislation, there are positives and negatives. Here are a few of the positives:
- The age at which an individual must begin taking RMDs increased from age 70 ½ to 72.
- Individuals are no longer penalized for withdrawing IRA funds prior to age 59 ½, if the withdraw is for a new birth or adoption.
- Individuals may now contribute to their IRA after age 70 ½ as long as there is earned income.
- Doing Qualified Charitable Distributions from your IRA at age 70 ½ still, up to $100k per year.
The biggest change takes place after the IRA owner (the “participant”) passes away. If the IRA beneficiary belongs to one of the classes outlined below, then the existing “stretch” rules still apply. In other words, after the participant’s death, IRS tables would be reviewed to calculate the beneficiary’s life expectancy to calculate the Required Minimum Distribution (“RMD”) to take each year over the life expectancy of the beneficiary.
Under the Act, however, most beneficiaries will not fit into one of the classes below, and therefore, will now be subject to a new 10-year rule. Prior to the Act, a beneficiary could withdraw the retirement account over their individual life expectancy, which could be for many years depending on the age of the beneficiary. This “stretch” allowed the IRA to grow income tax deferred for many years and lessen the income tax liability on the beneficiary receiving the retirement account. However, under the Act, beneficiaries now must liquidate the entire retirement account by the end of the year of the 10th anniversary of the death of the participant.
Let’s say IRA owner, John, dies in July 2020, and names his daughter, Jane, as the sole beneficiary of his IRA. Jane is 42 years old. Jane now receives John’s IRA as an inherited IRA. Because Jane is not one of the four classes of “eligible designated beneficiaries” listed below, she will not be able to stretch the IRA out over her life expectancy. The entire IRA will need to be liquidated by the end of the 10th year from the date of John’s passing (December 31, 2030), incurring all of the deferred taxes as a result. This is a substantially different outcome when compared to the prior law, under which Jane could have stretched the inherited IRA out for another 40 years income tax-deferred, with minimal taxable income each year.
The same result occurs when a trust is the beneficiary of the IRA, unless the trust meets certain additional requirements, and the beneficiary of the trust is “eligible” as described below.
Part 2: Eligible Beneficiaries
Who are the “eligible” beneficiaries that still qualify for the life expectancy stretch out instead of the new 10-year rule?
1. Spouses.
If a spouse is the named beneficiary, they can rollover the IRA into their own IRA and stretch the payout. In other words, they wouldn’t have to start taking RMDs until after they reached their own required beginning date after age 72. If the IRA was left to a spouse in a trust, with only the spouse named as the lifetime beneficiary, and if the trust met other requirements, the trust could take the benefits over the spouse’s life expectancy.
2. Minor Children.
If a minor child is named an IRA beneficiary, they may take distributions over their life expectancy until they reach the age of majority (typically age 18). According to the Act, once the minor beneficiary reaches the age of majority, they would fall under the 10-year rule. If an IRA is left to a trust for a minor child, the trust would take distributions over the minor child’s life expectancy until they reach the age of majority. However, this only applies if the trust meets certain drafting requirements; otherwise, the 10-year rule would apply. It’s important to note this exception only applies to the participant’s minor child; it does not apply to the participant’s grandchild, niece, nephew, or any other minor.
3. A disabled or chronically ill beneficiary.
If a disabled or chronically ill person, as defined by law, is named as a beneficiary, they are not subject to the 10-year rule. Instead, they would take RMDs annually over their life expectancy. If a trust is named for their benefit, then the trust would be treated the same and would use the disabled or chronically ill beneficiary’s life expectancy for RMDs. Again, this only applies if the trust meets certain drafting requirements.
4. A beneficiary who is less than 10 years younger than the IRA participant.
If a beneficiary is less than 10 years younger than the participant (like a younger sibling), that beneficiary would not be subject to the 10-year rule. Again, a trust would take RMDs based on the beneficiary’s life expectancy, assuming the trust meets certain drafting requirements.
If one of these eligible beneficiaries dies (or the minor reaches the age of majority), the 10-year rule would commence at the death of the eligible beneficiary.
Strategies to Stretch After the SECURE Act
To deepen your understanding of the SECURE Act, be sure and read Strategies to Stretch After the Secure Act to learn about a number of planning strategies to help minimize the tax burden beneficiaries may have.
