The passage of the SECURE Act in 2019 changed a few rules surrounding IRA taxes and beneficiary required minimum distributions that could affect the financial plan of an IRA beneficiary.
Before 2020, understanding required minimum distributions (RMD) was simple. The non-spouse beneficiary could take distributions over their expected lifetimes, which is referred to as a “stretch IRA.” If the beneficiaries were much younger than the original account owners, stretch IRAs minimized the taxes they were required to pay on each distribution.
Additionally, these IRAs provided a long period for the account to continue to grow on a tax-deferred basis. For a Roth IRA, the account would continue to grow on a tax-free basis.
The SECURE (Setting Every Community Up for Retirement Enhancement) Act that was passed in December of 2019 changed the way beneficiaries received money from inherited IRAs. After Dec. 31, 2019, non-spouse beneficiaries who inherited Traditional IRAs or those who inherited Roth IRAs had to take distributions during a 10-calendar year period, which would begin the year after the death of the IRA owner.
The new 10-year rule for individuals inheriting an IRA
The new 10-year rule took effect on Jan. 1, 2020, which means it will not affect the beneficiaries if the account owner died prior to Dec. 31, 2019. There are no RMDs that must be taken each year within the 10-year period; only the entire account must be distributed by the end of the 10th year.
For example, a beneficiary could decide to wait until the 10th year to take a distribution of 100% of the account and satisfy the new rules. As a result, beneficiaries will pay income tax on those assets much sooner than under prior law by ‘stretching’ RMDs over their life expectancy.
Exceptions to the new minimum required distribution rules
There are exceptions to this new rule, and they apply to spousal beneficiaries, disabled and chronically ill beneficiaries, as well as those beneficiaries who are not more than 10 years younger than the deceased IRA owner. There is a delay in the 10-year rule if a beneficiary is a minor and the child of the IRA owner. But the 10-year clock must start when the beneficiary reaches the age of majority (18 or 21 under applicable state law).
Below is a breakdown of each category:
Pre-SECURE Act (inherited account before January 1, 2020):
• Must take annual RMD.
This annual amount is based on the beneficiary’s age, account balance as of the end of the prior year, and the IRS life expectancy tables.
• Distributions start the year after the death of IRA owner.
• Distributions would be taken over expected lifetime.
• Individuals could delay taxes paid on distributions.
• Tax-free growth is promoted.
Post-SECURE Act (inherited account after Dec. 31, 2019):
• There is no annual RMD.
• You must spend down whole account balance in 10-years.
• You pay income tax sooner compared to requirements with stretch IRAs.
• Spending down of inherited assets is promoted.
There are Exceptions:
• Spousal beneficiaries: They can treat the inherited account as their own IRA and possibly delay RMDs until age 72.
• Disabled or chronically ill beneficiaries: They can utilize stretch IRA distributions, but both disabled and chronically ill individuals must provide certification by a licensed health care provider to meet the requirements.
• The beneficiary may not be more than 10 years younger than decedent: These individuals do not need to be related to qualify.
• Minor children: They may delay until age 18 or 21, and then apply the 10-year rule.
Although tax season is already over for 2021, many individuals inheriting an IRA from a parent, other family member or someone else may be asking themselves about the associated taxes and required minimum distributions going forward. Don’t hesitate to consult with a financial advisor or accountant with years of experience to help answer your IRA tax and related questions. It’s never too early to begin preparing for upcoming tax considerations. IRA owners and their intended beneficiaries may gain valuable advice prior to making decisions.
Pete Hoover was destined to be a financial advisor. He has always been intrigued by numbers and money matters. They represent captivating puzzles to be analyzed, shaped and fit into place as pictures of financial solidarity. For nearly 40 years, Hoover has tackled those financial puzzles. In 2005, he launched Hoover Financial Advisors, located in Malvern. Hoover can be reached by emailing pete@hfaplanning.