Impact of the SECURE Act on beneficiaries
IRA expert Ed Slott (IRAhelp.com) summarized in a recent newsletter the significant impact the SECURE Act of 2019 had on IRA beneficiaries. In this column, I will discuss some of the major changes.
The first thing to understand about the changes wrought by the SECURE Act is the timing. The changes affect beneficiaries who inherited IRAs after 2020. If you inherited an IRA prior to 2020, the old provisions are grandfathered. For example, prior to 2020, the 10-year rule was not in effect, and beneficiaries could determine their required distributions using single life expectancies longer than 10 years.
One of the major changes is when and how most beneficiaries take required minimum distributions (RMDs). If the IRA owner died on or after his/her required beginning date (RBD), the “at least as rapidly” rule applies to all beneficiaries required to take RMDs. The 10-year rule applies, and beneficiaries are required to take annual RMDs for years 1 through 9 after the IRA owner’s death. All funds remaining in the IRA must be taken out by the end of the 10th year after the owner’s death.
Some beneficiaries are exempt from the 10-year rule. These are known as eligible designated beneficiaries (EDBs).
If the owner dies on or after his RBD, and the beneficiary is an EDB, distributions must be taken over the “longer” of the remaining single life expectancy of the decedent, or the single life expectancy of the beneficiary. The distribution cannot extend past the life expectancy of the beneficiary.
There are five types of EDBs: surviving spouses, surviving minor children, those with disabilities, those suffering from chronic illness, and those who are not more than 10 years younger than the IRA owner. When determining the latter, the actual birth date of the IRA owner and beneficiary must be used.
If the beneficiary is an eligible designated beneficiary (EDB) as a result of a disability or chronic illness, documentation must be provided to the IRA custodian by Oct. 31 of the year following the death of the IRA owner.
Only minor children of the IRA owner are considered to be EDBs, and can take RMDs based on their single life expectancies until age 21. At 21, the 10-year rule becomes effective, and the account has to be emptied by the end of the 10th year. When a minor (under the age of 21) is named as a beneficiary, a guardian may be required by state law. A guardian can be named in the IRA owner’s will.
Some beneficiary forms permit the nomination of a guardian. Although a court can appoint a guardian, this is a long and expensive process, and should be avoided. If a minor, other than the minor child of the IRA owner is named as beneficiary, the 10-year rule is immediately in effect.
For example, in California, under the Uniform Transfer to Minors Act (UTMA), a custodian could establish an inherited IRA account for a minor. The beneficiary form could establish the custodian for the minor. In this situation, the custodian would control and manage the assets until the minor reaches 21. At 21, the minor would then be able to manage the assets independently. However, at 21, the 10-year rule would be in effect, and the account would have to be emptied by the end of the 10th year.
For large IRA balances, an IRA owner can use a trust. This option is more expensive and complex, but it may make sense if the owner wants to establish more control when minors are involved.
If a trust established for a minor child of the IRA owner meets certain requirements, and the child is the beneficiary of a “conduit trust,” then the RMDs can be stretched to age 21, when the 10-year rule would normally apply. With a conduit trust, the trustee is required to distribute the RMD to the beneficiary annually with the discretion to distribute more, if necessary.
Bottom line: The regulations associated with the SECURE Act are complex. Make sure you understand them, and take the distributions that are required of you. The penalty for not taking RMDs is 50% of the amount you did not withdraw in accordance with SECURE Act regulations.