What You Need to Know
- The Secure Act changed the inherited IRA rules for most non-spousal beneficiaries.
- A recent IRS publication created confusion around whether RMDs are required for those beneficiaries covered by the 10-year rule.
- An example presented by the IRS seemed to show that distributions needed to be taken every year. That's not the case.
The Setting Every Community Up for Retirement Enhancement (Secure) Act contained a number of changes affecting retirement accounts.
One of the most significant sets of changes are those the act made to the inherited IRA rules for many non-spousal beneficiaries. In particular, the rules require an inherited IRA to be emptied in 10 years.
A recent IRS publication illustrating the 10-year rule caused confusion among advisors over whether annual distributions must be taken over that period. An IRS spokesman told ThinkAdvisor the agency would revise the guidance to reflect that such distributions were not, in fact, required for beneficiaries covered by the 10-year rule.
More about that later, but first, here’s how the Secure Act changed the rules for inherited IRAs.
Death of the Stretch IRA
For IRAs inherited prior to Jan. 1, 2020, non-spousal beneficiaries had several options for taking distributions from the account. One popular option was taking required minimum distributions (RMDs) from the account based on the life expectancy of the beneficiary, especially if they were younger than the original account owner.
Taking RMDs over their lifetime allowed the beneficiary to stretch the tax-deferred growth of the account over their life expectancy. This option offered some tremendous opportunities to preserve this asset and even to pass it on to the next generation.
The Secure Act essentially eliminated the stretch IRA for most non-spousal beneficiaries for IRAs inherited on or after January 1, 2020. IRAs inherited prior to that date are still eligible to continue with RMDs as before.
Spousal beneficiaries of an IRA continue to have the option to treat the inherited IRA as their own. This allows clients to take RMDs based on their own age in the case of a traditional IRA. They can also treat an inherited Roth IRA as their own if they wish.
Eligible Designated Beneficiaries
The Secure Act created another class of beneficiaries known as eligible designated beneficiaries. A spouse is included in this group, and they can treat the IRA as an inherited IRA instead of as their own account. Clients in this situation will need your advice to decide upon the best option for their situation.
Other eligible designated beneficiaries include:
- A beneficiary who is chronically ill or disabled
- A beneficiary who is not more than 10 years younger than the account holder
- The child of the account holder who has not yet reached the age of majority. Once they do reach the age of majority, they are no longer considered to be an eligible designated beneficiary.
- Certain trusts
These beneficiaries may choose either the 10-year rule or take RMDs based on the single life expectancy table.
Other Non-Spousal Beneficiaries
Non-spousal beneficiaries who do not fall into the eligible designated beneficiary classification must withdraw the entire account balance within 10 years of inheriting the account for IRAs inherited on or after Jan. 1, 2020.
In the case of a traditional inherited IRA, this means that taxes will be due on the amounts withdrawn. For some clients, this could mean that their beneficiaries will see a high percentage of the account eaten up by taxes.
Amounts in an inherited Roth IRA are also subject to the 10-year rule, though withdrawals will be tax-free as long as the account owner had satisfied the five-year rule prior to their death.