Secure Act Makes Major Changes to the Rules For Inherited IRAs

Anyone who is considered a “Designated Beneficiary” will be subject to the new rule to withdraw an inherited retirement account within 10 years of the date the original owner dies. Generally, this means the 10 year rule will apply if you name your adult children as beneficiaries. It will also apply if you name your nieces, nephews, and other friends and relatives who are more than 10 years younger than you. As discussed, there are exceptions if you name a disabled or chronically ill beneficiary.

This 10 year rule applies to IRAs, ROTHS, 401(k)s, 403(b)s, and most retirement accounts that were considered deferrable retirement accounts. There is a small window for compliance for retirement accounts subject to collective bargaining agreements.

Who Is Exempt from this 10 Year Withdrawal Requirement?

As discussed above, under the Secure Act, most people who inherit an IRA, 401(k), 403(b), ROTH, or other retirement account are required to withdraw such retirement account within 10 years of the death of the original owner. This begs the question, who is exempt from this 10 year withdrawal requirement? Anyone who is categorized as an “Eligible Designated Beneficiary” is exempt from the 10 year withdrawal requirement.

That being said, each Eligible Designated Beneficiary has their own set of rules. Specifically:

1. A surviving spouse may:
   • roll the retirement account into his or her name, becoming the owner; or
   • treat the retirement account as an inherited IRA (or an inherited ROTH if appropriate) and withdraw the account over his or her life expectancy; or
   • treat the retirement as if it is still owned by the deceased spouse and withdraw it over the deceased spouse’s actuarial life expectancy. [Caveat – I am trying to verify this third option, but I think it is true. This may be a useful option if the deceased spouse is significantly younger than the surviving spouse.]
   • Unclear – whether a Marital IRA Stretch Trust still works as an effective tool. (I will analyze this in the future as it can be critical for planning for second marriages and blended families.)
2. A beneficiary who is not more than 10 years younger than the Original Owner may:
   • treat the retirement account as an inherited IRA (or an inherited ROTH if appropriate) and withdraw the account over his or her life expectancy.
3. Disabled Beneficiaries and Chronically Ill individuals may:
   • treat the retirement account as an inherited IRA (or an inherited ROTH if appropriate) and withdraw the account over their life expectancy; or
   • receive the retirement account in a Special Needs Trust designed as an Accumulation IRA Stretch Trust and still withdraw the account over their life expectancy. (See I.R.C 401(a)(9)(H)(iv) & (v) which was added to the final version of the Secure Act but not in the original passed by the House.)
   • Disabled Beneficiaries are defined under Internal Revenue Code Section 72(m)(7) and Chronically Ill individuals are defined under I.R.C. 7702B(c)(2).
4. Minor children of the Original Account owner may:
   • take age based Required Minimum Distributions (RMDs) while they are a minor and the 10 year rule does not start until after they reach the age of majority.
   • Important – this exception to the 10 year rule does NOT apply to anyone other than a minor child of the Original Owner. All other minor beneficiaries are subject to the 10 year withdrawal requirement regardless of age.
   • Unclear – whether an IRA Stretch Trust is still better than naming a minor. For tax purposes, it is likely better to name the minor child rather than a trust. However, this means at the age of majority, the child can also withdraw the entire account and blow it. It may be dependent on the client, the number of children, the ages of the children to determine the most effective strategy. (I will analyze this in the future.)

5 Year Rule Still Applies in Certain Situations

If you name a beneficiary of your retirement account who is not considered a Designated Beneficiary or an Eligible Designated Beneficiary under the Secure Act, such beneficiary must still withdraw the retirement account over a 5 year period, not the new 10 year period.  As a practical matter, if you are naming an estate, a trust that doesn’t have look-through provisions (such as an IRA Stretch Trust), or an entity as a beneficiary, the 5 year rule will apply.  Accordingly, extreme care must still be taken when naming a trust as a beneficiary rather than an individual. Otherwise you could shorten the time period for which the retirement account must be withdrawn.

Are Required Minimum Distributions Required if the 10 Year Rule Applies?

No. If the 10 year rule applies, there is no requirement to take annual distributions. Required Minimum Distributions (RMDs) are still required while you are considered an Eligible Designated Beneficiary.

Grandfathering Rules

If the owner of a retirement account died before January 1, 2020, then the old rules will apply, and a beneficiary (the “Inherited IRA owner”) can withdraw the account over his or her life expectancy.  However, if this Inherited IRA owner dies after January 1, 2020, the new designated beneficiaries will no longer be able to stretch out the retirement account over the life expectancy of the original Inherited IRA owner. The 10 year rule will apply to those secondary beneficiaries.

Uncertainty Created By the Secure Act

As with most new laws, the Secure Act creates a significant amount of uncertainty. In particular, it is unclear what will happen if a person dies naming an existing outdated IRA Stretch Trust. The formulas in most trust documents relied on old rules and definitions which simply are unworkable. There is also uncertainty surrounding what happens when the beneficiary of a grandfathered IRA Stretch Trust dies.

Benefits of the Secure Act

On the plus side for owners of a retirement account, the Secure Act allows you to:

1. Continue making payments into your retirement account, regardless of age, as long as you have earned income.  (Previously, you could not contribute after age 70.5);
2. Mandatory distributions for owners of retirement accounts have been pushed back from age 70.5 until age 72.

Who is Most Adversely Affected by the Secure Act?

Anyone who has named an IRA Stretch Trust as a beneficiary of retirement account is adversely affected. However, it most negatively affects those in second marriages or blended families and those who have plans designed around leaving retirement accounts to other people’s minor children such as particularly grandchildren, great-grandchildren, nieces, and nephews.

Overall Thoughts on the Secure Act

This major change to rules for Inherited IRAs, 401(k)’s, and ROTHs can have dramatic consequences for you, particularly if you have created an IRA Stretch Trust as part of your estate plan.  I strongly recommend that if you have created an IRA Stretch Trust as part of your estate plan that you contact your estate planning attorney as soon as practical to decide whether or not you need to modify your plan and beneficiary designations.