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The InSECURITY of the SECURE Act

At the end of 2019, Congress passed the “Setting Every Community Up for Retirement Enhancement” (SECURE) Act of 2019. The new law, which represents a major overhaul of the rules for retirement plans and IRAs, is effective on January 1, 2020. The new law effectively ends “stretch IRAs” that enable non-spouse beneficiaries to extend RMDs over their lifetime.  As a result, the security of beneficiaries to receive lifetime distributions is now unavailable. Hence, the SECURE Act results in “inSECURITY” for some people. Instead, all funds from inherited accounts, including IRAs and qualified plans, must be distributed to non-spouse beneficiaries within ten years of the account owner’s death. The rule does not apply to distributions over the life or life expectancy of a non-spouse beneficiary and is allowed if the beneficiary is a minor, disabled, chronically ill or not more than ten years younger than the deceased account owner. The following are several key provisions in the SECURE Act.

10-Year Rule Specifics
When applicable, the new 10-year rule for required minimum distributions (RMDs) generally applies regardless of whether the account owner dies before or after his or her RMD required beginning date. The SECURE Act also raised the age at which the RMD rules kick in from 70½ to 72 for account owners who attain age 70½ after 2019. So, the required beginning date for those account owners is April 1 of the year following the year age 72 is attained.  There are two other key points to be aware of: Following the death of an eligible designated beneficiary, the account balance must be distributed within 10 years. After a child of the account owner reaches the age of majority, the account balance must be distributed within 10 years after that date.

Old Rules

Before the SECURE Act, the required minimum distribution (RMD) rules allowed a nonspouse beneficiary to gradually drain inherited IRAs over the beneficiary’s IRS-defined life expectancy.

For example, Sally is 40 years old when she inherits her elderly Aunt Beth’s $500,000 Roth IRA. The current IRS life expectancy table estimates that Sally will live for another 43.6 years.  Sally must start taking annual RMDs from the inherited account by dividing the account balance as of the end of the previous year by her remaining life expectancy as of the end of the current year. So, her first RMD would equal the account balance as of the previous year-end divided by 43.6, which would amount to only $11,468, or 2.29% of the balance ($500,000 divided by 43.6 years). Her second RMD would equal the account balance as of the end of the following year divided by 42.6, which translates to only 2.35% of the balance. And so on until the account is fully depleted.

Under the old law, the RMD rules allowed nonspouse beneficiaries to keep an inherited account open for many years and stretch the tax advantages for those years. With an IRA, this is sometimes called the “stretch IRA” strategy. It’s particularly advantageous for inherited Roth IRAs, because the income those accounts produce can grow and be withdrawn free from federal income tax. So, under the pre-SECURE Act RMD rules, a stretch Roth IRA could provide protection from future federal income tax rate increases for many years.

New Rules

The SECURE Act requires most nonspouse IRA and retirement plan beneficiaries to empty inherited accounts within 10 years after the account owner’s death. This is an unfavorable change for beneficiaries who would like to keep inherited accounts (generally traditional and Roth IRAs) open for as long as possible to continue reaping the tax advantages.

This change will not affect account beneficiaries who want to quickly drain inherited accounts or account owners who empty their accounts during their retirement years. It only affects certain nonspouse beneficiaries who want to keep inherited accounts open for as long as possible to reap the tax advantages.

This change also will not immediately affect accounts inherited by a so-called “eligible designated beneficiary.” This term refers to:

  • The surviving spouse of the deceased account owner,
  • A minor child of the deceased account owner,
  • A beneficiary who’s no more than 10 years younger than the deceased account owner, or
  • A chronically ill individual as defined under the tax law.

Other nonspouse beneficiaries will get hit by the new 10-year account liquidation requirement. For example, continuing with the previous hypothetical situation, Sally could only keep the Roth IRA that she inherited from Aunt Beth open for 10 years after her death, if Aunt Beth dies in 2020 or later.

Under the exception for eligible designated beneficiaries, RMDs from the inherited account can generally be taken over the life or life expectancy of the eligible designated beneficiary, beginning with the year following the year of the account owner’s death.

The unfavorable changes to the RMD rules under the SECURE Act are generally effective for RMDs taken from accounts whose owners die after 2019. As a result, the new insecurity of some beneficiaries being unable to receive lifetime distributions will require estate plan revisions for some people. The RMD rules for accounts inherited from owners who died before 2020 are unchanged.