One of the most complex areas of retirement planning today is figuring out the rules for distributions from inherited retirement accounts. How do rules for spouses and non-spouses differ? When should required distributions on inherited retirement accounts begin? Which IRS life expectancy table applies when calculating minimum distributions? What happens if no beneficiary is designated?
The introduction of the SECURE Act’s 10-year distribution rule further complicates this planning by establishing new guidelines for distributing inherited accounts, and creating a new class of beneficiaries (eligible designated beneficiaries, or EDBs). Spousal beneficiaries are considered EDBs and can still stretch required distributions based on their remaining life expectancy. Most non-spouse beneficiaries can no longer “stretch” distributions over time. There are, however, cases where non-spouse beneficiaries are considered EDBs and eligible for life expectancy distribution instead of the 10-year rule:*
- Disabled
- Chronically ill
- Not more than 10 years younger than the retirement account owner
- A minor child of the account owner (however, the 10-year distribution rule applies when the beneficiary reaches age 21)
Lastly, proposed regulations issued by the Treasury Department last year, create different rules for the 10-year distribution period based on when the original account owner died. Generally, if the account owner was already subject to required minimum distributions, the beneficiary, at a minimum, would have to take annual distributions based on life expectancy for the first nine years, followed by a full distribution of the inherited account by the end of the tenth year.
How the 10-year rule applies
The new 10-year rule under the SECURE Act applies to inherited accounts where the owner died after 2019. While a non-spouse beneficiary who inherited prior to 2020 can still stretch distributions, a successor beneficiary may be subject to the 10-year rule upon the death of the original beneficiary. To provide clarification on how the new distribution rule applies, it may be helpful to consider different examples. These examples assume that the proposed regulations mentioned above are eventually finalized.
IRA owner died before the SECURE Act 10-year rule took effect in 2020.
Facts: Alfred died at age 85 in 2015 leaving his IRA to his daughter Betty who has been taking distributions based on her life expectancy. Betty dies in 2022, leaving the remainder of the inherited IRA to a successor beneficiary, her son Charlie.
Distribution schedule:
2015: The year-of-death RMD must be taken for Alfred (based on his life expectancy factor from the IRS uniform lifetime table).
2016–2022: Betty takes distributions based on her life expectancy (from IRS single life expectancy table).
2023–2033: The 10-year rule applies to successor beneficiary Charlie. At a minimum, Charlie must continue minimum distributions based on Betty’s life expectancy, and the IRA must be fully distributed by the end of 2033.
IRA owner who was subject to RMDs dies after 2019 when the SECURE Act 10-year rule applies.
Facts: Alfred died at age 85 in 2021, leaving his IRA to his daughter Betty.
Distribution schedule:
2021: The year-of-death RMD must be taken for Alfred. The 10-year distribution period begins the following year.
2022–2031: At a minimum, Betty must take annual distributions (based on her life expectancy factor from the IRS single life expectancy table), followed by a full distribution by the end of 2031.
IRA owner not subject to RMDs dies after 2019 when the SECURE Act 10-year rule applies.
Facts: Alfred died at age 70 in 2021, leaving his IRA to his daughter Betty.
Distribution schedule:
2021: No year-of-death RMD is due since Alfred died prior to reaching his required beginning date (RBD). The 10-year distribution period begins the following year.
2022–2031: No annual distributions are required for Betty since Alfred died prior to reaching his RBD. At a minimum, the inherited IRA must be distributed by the end of 2031.
Consult an advisor
It is important to consult with an advisor and get professional advice. When errors are made around RMDs and distributions, there may be penalties involved. Another important reason to meet with an advisor is tax planning. Since the new 10-year rule may result in retirement account balances being distributed sooner than anticipated, that may lead to unintended income tax issues for beneficiaries.
For more information, see “Distribution planning under the SECURE Act.”
*The Treasury Department’s proposed regulations §1.401(a)(9)–4(e)(4)(ii) – (iv) provide a safe harbor for individuals who are considered disabled by the Social Security Administration. Additionally, two different definitions are provided for disability. For those age 18 and over, disability refers to those unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment that can be expected to result in death or to be of long-continued and indefinite duration. For those under age 18, disability refers to a medically determinable physical or mental impairment that results in marked and severe functional limitations and that can be expected to result in death or to be of long-continued and indefinite duration. The definition of chronically ill is based on IRC§7702(B)(c)(2). This generally means that the individual cannot perform at least two out of the six activities of daily living (ADLs).
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