, ,

9 Things to Know About IRA Beneficiaries Under the Secure Act

The Setting Every Community Up for Retirement Enhancement (Secure) Act of 2019 upended the withdrawal and taxation rules for inherited individual retirement accounts for most non-spousal beneficiaries.

Most dramatically, the Secure Act established a 10-year rule for withdrawing from inherited IRAs that eliminated the popular, but at times controversial, ability to “stretch” inherited IRAs for these beneficiaries. But the law also included a significant number of other important changes that financial advisors and their clients have to grapple with in the income planning and estate process.

1. Certain beneficiaries can still stretch their inherited IRAs.

Generally speaking, the Secure Act established that “non-eligible designated beneficiaries” who inherited an IRA in 2020 or later are subject to a 10-year payout period. Those who are eligible designated beneficiaries, on the other hand, can generally stretch the withdrawal according to their own life expectancy.

Eligible designated beneficiaries include surviving spouses, minor children of the account owner, disabled beneficiaries, chronically ill beneficiaries and beneficiaries who are less than 10 years younger than the account owner.

One caveat with respect to minor children inheriting IRAs is that the life expectancy rule applies only until the child reaches the age of majority, at which point the 10-year distribution period applies.

Credit: Adobe Stock

2. Non-eligible designated beneficiaries have their own rules.

Hagerty emphasized that the regulatory picture facing non-eligible designated beneficiaries is currently in flux, but the general rules are clear enough.

The Secure Act declares that such beneficiaries will have to withdraw all the funds from the account within 10 years. While many experts first thought the law meant that inheritors could withdrawal funds at any point during that window, the IRS’ proposed regulations actually stated that those beneficiaries would be subject to annual RMDs “during” the 10-year period if the account owner died after their required beginning date.

Because those proposed regulations were not released until 2022, the IRS offered relief and waived 2021 and 2022 RMDs. In Notice 2023-54, the IRS again waived 2023 RMDs for non-eligible designated beneficiaries of individual retirement account owners who died after their required beginning date (including accounts inherited in 2022).

Credit: Shutterstock

3. Non-designated beneficiaries have yet another set of rules.

Hagerty noted that more Americans today are viewing their IRAs as a vehicle for legacy giving, both to their own heirs and potentially to charities or other entities. Generally, she explained, nonqualified trusts and charitable entities that are not people are classified as “non-designated beneficiaries,” and these inheritors have their own rules to consider.

For example, If the IRA owner or plan participant dies before the owner’s required beginning date, the account must be emptied under a five-year rule. If owner dies on or after their RMD date, RMDs must be taken over the deceased IRA owner’s remaining single life expectancy.

Hagerty said many clients fail to realize this, and the result is that more of their IRA may end up going to paying taxes than was anticipated.

Credit: Adobe Stock

4. Surviving spouses have a significant number of options.

As Hagerty explained, there are a number of inherited IRA withdrawal options that apply to a surviving spouse. These include following the sole beneficiary framework; enacting a spousal rollover; following the inherited IRA framework according to the life expectancy method; following the inherited IRA framework according to a five- or 10-year model; or simply taking a lump-sum distribution.

The important thing to realize is that, while some of these methods are likely to be more effective for more people (such as following the remaining life expectancy model), there are going to be cases in practice where each method makes the most sense.

Credit: Adobe Stock

5. Spousal rollovers have their nuances.

The basic approach to a spousal rollover is to transfer the inherited assets directly into a new or existing IRA. This allows the inheritor to simply treat the assets as their own, and it’s only available if the spouse is the sole beneficiary.

The main benefits are that the IRA assets continue to grow tax-deferred, so this is likely to be more attractive in cases where the surviving spouse is meaningfully younger than the decedent.

Of course, if the spouse is under 59 1/2, they will be subject to normal IRA distribution rules, so this approach should really only be utilized if the funds are expected to be used in their own retirement.

Credit: Adobe Stock

6. Distribution rules are different for spouses more than 10 years younger.

If the spouse inherits the IRA and hopes to base the RMDs on their own life expectancy, there is an important caveat to consider. Namely, spouses who are more than 10 years younger than the original owner must instead use IRS’ joint and last survivor table, and that fact can change the calculus.

With this approach, there is no 10% early distribution penalty if funds are taken from the inherited account, so this approach is ideal for a spouse under 59 1/2 who needs immediate distributions.

Another note is that the account name must include the deceased owner’s name to be clear that it is an “inherited” or “beneficiary” IRA, Hagerty advised, giving the following as an example of a well-named inherited IRA: “John Johnson IRA (deceased 5/1/2018) F/B/O Jane Johnson, beneficiary.”

Credit: Shutterstock

7. Under proposed rules, ‘minor’ means under 21.

Hagerty pointed out that, under recently proposed regulations, a minor child for the purposes of stretching an IRA remains a minor until their 21st birthday.

Importantly, the minor child cannot be “any” minor child. Instead it must be “the minor child of the original owner.” Once the child no longer qualifies as a minor, they are subject to the 10-year rule.

Credit: Shutterstock

8. Considerations for disabled and chronically ill IRA beneficiaries.

The rules for disabled and chronically ill IRA beneficiaries are fairly straightforward, Hagerty said, but they are very important to understand clearly.

For example, the definition of disability for those under 18 means they must have a condition expected to result in death or to be of long-continued and indefinite duration. For those over 18, the definition shifts to state that they need to have a condition which means they are unable to engage in any substantial gainful activity and that can be expected to result in death or to be of long-continued and indefinite duration.

This is another area where the definitions are not yet finalized, Hagerty warned.

Likewise, “chronically ill” is defined by a certification from a licensed health care practitioner that the individual is “unable to perform at least two activities of daily living for an indefinite period which is reasonably expected to be lengthy in nature.”

Credit: Adobe Stock

9. Complexities arise when trusts are named as IRA beneficiaries.

Hagerty explained that trusts generally cannot own an IRA when the original IRA owner is living, and various trusts do not qualify as either eligible or non-eligible designated beneficiaries.

Additionally, eligible designed beneficiaries may actually lose their ability to stretch the IRA if a trust is also named as beneficiary.

Essentially, Hagerty explained, this means there is no tax benefit that can be accomplished with a trust that cannot be accomplished without one, and clients should only name a trust as an IRA beneficiary if it is a solution to a specific problem.

Credit: Adobe Stock

By: John Manganaro – 03-11-2024