Successor beneficiaries and IRA distributions
The SECURE Act of 2019 changed the regulations regarding beneficiaries of IRAs and other retirement accounts. After Dec. 31, 2019, most beneficiaries no longer have the ability to stretch out their inheritance over their lifetime. They have only 10 years in which they can withdraw the assets of their inherited traditional IRA or Roth IRA.
Beneficiaries are not required to make withdrawals in years one through nine following the death of the original account owner. However, by the end of the 10th year, all of the funds must be withdrawn.
The beneficiary may name a successor beneficiary, who would inherit the account if the original beneficiary dies during the 10-year period.
Under the regulations prior to the SECURE Act, if the first beneficiary died with a remaining single life expectancy of 40 years, then the successor beneficiary, regardless of age, could continue to stretch the required minimum distributions (RMD) over the remaining life expectancy associated with the original beneficiary. That is no longer the case.
The SECURE Act defined a class of eligible designated beneficiaries (EDBs) who can stretch out payments if they are the original beneficiaries. These EDBs include spouses and minor children of the account owner, disabled or chronically ill persons, and persons not more than 10 years younger than the original owner. However, these EDBs are not allowed to stretch out RMDs when they are successor beneficiaries.
Here are some examples of how these regulations could play out in real-life situations.
Example 1: Mr. James Jones inherited an IRA from his mother, who died in June 2020. Because his mother died after Dec. 31, 2019, SECURE Act provisions are in effect, and Mr. Jones has 10 years from June 2020 to withdraw the assets in the inherited IRA. Mr. Jones also has his own traditional IRA. He has named his spouse, Shirley Jones, as the beneficiary of his
IRA and also the successor beneficiary of the account he inherited from his mother. Let’s assume Mr. Jones dies in June 2021, one year after he inherited his mother’s account.
Shirley Jones is an EDB as the spouse of James Jones. She will be allowed to stretch out the IRA she inherited from her husband’s IRA based on her own life expectancy, because she is the original beneficiary and she is an EDB. However, because she is the successor beneficiary of the IRA account her husband inherited from his mother, she would only have nine years to withdraw all the assets from the inherited IRA.
Beneficiaries and successor beneficiaries who inherited prior to the passage of the SECURE Act, and are currently stretching out RMDs, are “grandfathered” under the SECURE Act. Beneficiaries can continue to receive payments until they die. However, no matter whom they designate as beneficiaries of these accounts, these successor beneficiaries are required to take RMDs over 10 years.
Example 2: Henry Smith inherited a Roth IRA from his deceased wife in December 2018. He has been taking RMDs based on his life expectancy. He has named his minor children as beneficiaries. Let’s assume he dies in December 2021. The children he named as beneficiaries would have 10 years from the date of his death to withdraw all the assets in his inherited account. The fact that his minor children were categorized as EDBs is not relevant. Only one stretch payment is permitted. However, because the account was a Roth account, no income taxes would have to be paid.
If you become a beneficiary or successor beneficiary, and are facing a 10-year (or shorter) withdrawal period, you should consider taking yearly RMDs rather than waiting for the 10th year if the withdrawals are from traditional IRAs and are taxable. If the accounts are sizable, you should take into consideration the potential large income-tax liability if you wait until the 10th year for withdrawal.