Written by Ashley G. White, JD, CPA

The SECURE Act (the “Act”) became law effective January 1, 2020, and made significant changes to the rules regarding required minimum distributions (RMDs) and inherited IRAs and retirement plans.  Specifically, the Act largely eliminated the “stretch” IRA by requiring, subject to a few specific exceptions, that all benefits must be paid out of the plan by December 31 of the tenth calendar year following the death of the plan participant (the “10 Year Rule”).

Under the Act, the only five categories of “Eligible Designated Beneficiaries” that remain eligible to stretch out distributions over their lifetimes are (1) a surviving spouse; (2) a minor child; (3) a disabled beneficiary; (4) a chronically ill beneficiary; or (5) an individual not more than ten years younger than the deceased plan participant.  Notably missing from this list are the adult children of a deceased plan participant, which make up a large portion of those inheriting retirement plans. Those beneficiaries that do not fall into these five categories are considered “Non-Eligible Designated Beneficiaries,” and they must adhere to the 10 Year Rule.

The regulations are proposed to be effective beginning with 2022 RMDs and are extensive, covering more than 275 pages. The most noteworthy item comes from guidance regarding RMDs following the death of a plan participant who dies after reaching age 72. Specifically, the proposed regulations state that a beneficiary who inherits an IRA or retirement plan from a plan participant who dies after reaching age 72 will be required to take distributions beginning on the first calendar year following the year of the decedent’s death, each year until the 10th year following the calendar year of the decedent’s death. At this point, all of the remaining funds must be distributed outright to the beneficiary. This provision came as a surprise to many practitioners and commentors who were under the impression that beneficiaries that were subject to the 10 Year Rule would not be required to take ANY distributions until December 31 of the tenth year following the decedent’s death, no matter how old the plan participant was at the age of death.

By contrast, when the IRA owner or retirement plan participant dies before reaching the age of 72, no annual RMDs are required under the 10 Year Rule. In that case, only the 10 Year Rule payment must be satisfied. In fact, the non-eligible designated beneficiary can take as little or as much as he or she wants during years one through nine, as long as the entire account balance is distributed by the end of the 10-year term.

Just as with the failure to take an RMD while alive, failure to take the required RMD by a beneficiary who is required to take it under the regulations has severe consequences:  specifically, a 50 percent excess accumulation penalty. The same 50 percent penalty applies to failure to withdraw the remaining amount by December 31 of the 10th year, and it will continue to be imposed in each year beyond year 10 that the funds remain in the account.  Note that this is in addition to the ordinary income tax rates imposed when the funds are withdrawn.

Another notable piece of clarification coming from the proposed regulations is regarding the definition of a minor child in order to qualify as an Eligible Designated Beneficiary.  Under the initial regulations, majority was defined based on the law of each state or as late as age 26 if the child was a student. Under the proposed regulations, children are considered to reach the age of majority upon their twenty-first birthday, irrespective of the law of the state in which the children reside or their status as students. The 10 Year Rule comes into play upon reaching age 21, thus making it required to fully withdraw all the funds by age 31.

The proposed regulations also go into great detail in clarifying when a trust beneficiary is treated as a direct beneficiary of the plan participant for purposes of qualifying as an eligible designated beneficiary in order to secure the stretch treatment. In a very taxpayer-favorable move, the proposed regulations allow for amendments, modifications and reformations of trust documents to be made no later than September 30 of the calendar year following the year of the plan participant’s death. However, from a legal perspective, the trustee would need to be given the power to make such adjustments under the trust agreement and/or state law. The additional regulations regarding trusts designated as IRA or plan beneficiaries are beyond the scope of this article, but please contact your trusted BMSS advisor with any specific questions that you may have regarding trusts or the application of these rules generally for any other beneficiaries at (833) CPA-BMSS.

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