SECURE Act: New Required Minimum Distribution Rules for Beneficiaries
Article

SECURE Act: New Required Minimum Distribution Rules for Beneficiaries

by Kelly Gillette
April 22, 2021

With the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 came significant changes in the required minimum distribution (RMD) rules governing inherited IRAs and qualified retirement plans. Understanding what has changed under the new law is critical to making sure your original intent and expectations are still being met and your heirs are not surprised.

Background

For deaths prior to January 1, 2020, many beneficiaries were able to take distributions from IRAs and qualified retirement plans in installments spread over their life expectancies. This spread or “stretching” of distributions was beneficial in a couple of ways. First, it allowed the funds to remain invested and growing in a tax-deferred environment. Second, it provided for a smaller amount being taxed each year, oftentimes keeping those dollars in lower tax brackets. Lastly, it allowed for extended protection of those funds from creditors. 

Now, under the SECURE Act, many of those beneficiaries must take out the inherited funds within 10 years, rather than over their life expectancy.  This amounts to essentially the end of the “stretch IRA” for many beneficiaries and undoes planning undertaken by account owners. 

Designated Beneficiaries (DBs) and Non-Designated Beneficiaries (NDBs) made up the two main categories of beneficiaries prior to the SECURE Act.  DBs are generally defined as living persons and could also include certain trusts that are considered “see-through” (conduit or accumulation trusts). NDBs are those beneficiaries who are not DBs and include beneficiaries such as persons 10 years or more younger than the account owner, non-eligible minor children, certain trusts and estates. 

Now, under the SECURE Act, the DB category is broken into two sub-categories, which are Eligible Designated Beneficiaries (see below) and what are commonly referred to as “Other” or “Non-Eligible” Designated Beneficiaries (designated beneficiaries who are not considered eligible). For the most part, the Eligible Designated Beneficiaries will still be able to use their life expectancy for distributions of inherited accounts. Those not in this category may face unexpected and unfavorable outcomes. 

It is imperative that you understand what category your beneficiaries fit into as well as the related RMD rules that apply to them. Failure to do this could have significant impacts on your original plan.

What You Need to Know

  • If inherited prior to 2020 use “old” law. The rules discussed here under the SECURE Act do not apply to beneficiaries who inherited IRAs and/or qualified retirement accounts from account owners who died prior to January 1, 2020.
  • Naming beneficiaries is important. This helps ensure your plan assets will pass to the intended heirs, affects the distribution options available based on the beneficiary classification, and can help keep probate and estate costs down.
  • Eligible Designated Beneficiaries. This group is generally able to use the beneficiary life expectancy as they did under the pre-SECURE Act rules.
    • Surviving spouse
    • Person less than 10 years younger
    • Eligible minor child (see below for qualifications)
    • Disabled
    • Chronically Ill
  • Eligible minor child is not just any child. This is the original account owner’s children only. Grandchildren, nieces and nephews, for example, do not qualify as an EDB.
  • Be aware that two rules can apply to one beneficiary. Eligible minor children will begin taking distributions over their life expectancy, but this window is limited. Once they reach the age of majority, which is usually 18 or 21 (this varies by state and in some jurisdictions could extend to age 26 if they are still in school ), the distribution rule changes to the 10-year rule.
  • Distributions may subject minor children to the “kiddie tax.” Children under 18 at the end of the year and certain children ages 18-23 are potentially subject to tax at their parent’s marginal tax rate on IRA distributions.
  • One-time treatment for EDB. Eligible beneficiary rules only apply at the death of the original account owner. Once the initial EDB dies, the inherited account must be paid out over 10 years from the EDB’s death.
  • Penalties can be severe. In addition to potential negative tax consequences, if the account has not been distributed by the end of the 5th or 10th year following the account owner’s death, any remaining funds are subject to a 50% penalty or “excise tax.”

Questions to Ask

Once you familiarize yourself with the new rules, there are several important questions to consider.

  • Do I have a trust named as a beneficiary of an IRA, ROTH IRA and/or qualified retirement plan or no designated beneficiary?
  • Do I have minor children who I would not want to start receiving distributions if something happened to me?
  • If so, have I consulted a professional to review and advise on the outcome at my passing under the new law so I can make adjustments as needed?

Reach out to one of our experts should you want to review these questions or others about the tax implications of the Act.

FOR REFERENCE

The following chart and information are for reference purposes to be used in conjunction with the information above:

RMD RULES UNDER THE SECURE ACT Designated Beneficiary Non-Designated Beneficiary
Direct Individual Conduit Trust Accumulation Trust IRA Owner Death Before 72 (RBD) IRA Owner Death After 72 (RBD)
Eligible Designated Beneficiary Surviving Spouse Life Expectancy Life Expectancy 10-Year
Person Less Than 10 Years Younger Life Expectancy Life Expectancy 10-Year
Eligible Minor Child Life Expectancy (Until majority, then 10-Year) Life Expectancy (Until majority then 10-Year) 10-Year
Disabled OR Chronically Ill Person Life Expectancy Life Expectancy Life Expectancy
Non-Eligible Designated 10-Year 10-Year 10-Year
Non-Designated Beneficiary 5- Year Ghost Life Expectancy

DEFINITIONS

  • Designated Beneficiaries – Individuals who are named as beneficiaries, do not share the IRA or plan account with non-individuals, and are named in a timely manner. This can include certain “see-through” trusts if properly structured.
  • Non-Designated Beneficiaries – Non-individuals such as charities, the original account owner’s estate and non-qualified (not see-through) trusts.
  • Life Expectancy Rule – The account must be distributed in annual installments over the life expectancy of the beneficiary.
  • 5-Year Rule – The entire account must be withdrawn before five years after the death (more precisely, by December 31 of the year that includes the 5th anniversary of the participant’s death).
  • 10-Year Rule – The entire account must be withdrawn before ten years after the death (more precisely, by December 31 of the year that includes the 10th anniversary of the participant’s death).
  • Ghost Life Expectancy Rule – The account must be distributed in annual installments over what would have been the remaining single life expectancy of the participant had he/she not died.
  • Qualified Designated Beneficiary “See-Through” Trusts (Conduit and Accumulation Trusts) – Must meet four criteria: 1) Valid under state law, 2) irrevocable (or irrevocable upon death of original account owner), 3) trust beneficiaries must all be identifiable as eligible to be designated beneficiaries, and 4) copy of trust documents must be provided to the IRA custodian by October 31 of the year following the account owner’s death.
  • Conduit Trust – A trust requiring all IRA distributions received be distributed out of the trust to the individual trust beneficiary.
  • Accumulation Trust – A trust that allows for IRA distributions received to be accumulated and held within the trust rather than immediately distributed to the individual trust beneficiary. Trust terms determine timing of distributions to beneficiaries from the trust.

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