by Scott Christianson, CFP®
Executive Vice President
Portfolio and Wealth Management
The SECURE Act, which became effective in January of 2020, brought significant changes to the retirement planning landscape. The wide-sweeping legislation impacted retirement plans in numerous ways. The changes included an increase to the beginning age for required minimum distributions (RMDs), removal of the IRA contribution age limit, expansion of retirement plan access, legal protections for employers and limitations for certain IRA distribution periods for beneficiaries. We have been keeping clients apprised of developments since 2019, as seen in this blog post.
Much of the SECURE Act was viewed as a positive for retirement plan participants, but a common tradeoff for the positive changes came in the way of a 10-year limit for certain post–death distributions to beneficiaries of inherited retirement plans. Recently, the Internal Revenue Service (IRS) released proposed regulations that aim to clarify many of the specifics around how the SECURE Act would impact IRA beneficiaries.
In the proposed regulations, the IRS has clarified the three general types of retirement plan beneficiaries and their respective RMD periods for post-SECURE Act beneficiaries.
Eligible Designated Beneficiaries
Surviving spouses and others in the “eligible designated beneficiaries” category would continue to be allowed to follow the so-called “stretch IRA” distribution period in an inherited IRA. This more-generous RMD schedule over one’s life expectancy generally allows for a longer, more advantageous tax deferral.
Non-Eligible Designated Beneficiaries
Adult children are the most common group that fall in the “non-eligible designated beneficiaries” category. These beneficiaries are subject to a more restrictive 10-year distribution period within an inherited IRA. The proposed regulations include important clarification on how the 10-year distribution period is expected to work. Beneficiaries would be bifurcated into two subcategories depending on whether the original retirement plan owner was subject to RMDs at the time of their death.
Beneficiaries who inherit a retirement plan where the original owner was subject to RMDs would have an annual computed RMD for years one-through-nine and then a final RMD to deplete the balance of the inherited IRA in year 10. Alternatively, beneficiaries who inherit a retirement plan where the original owner was not taking RMDs would only need to satisfy the requirement to fully distribute the balance by the end of the 10th year.
It is worth noting, for those who have a pretax inherited IRA and are only subject to a year 10 RMD, it may still be beneficial to take earlier, non-required distributions. This may offer a tax advantage by spreading taxable distribution income over multiple tax years potentially reducing the effective tax bracket. On the second page of our fourth quarter 2020 Wealth Management Insights publication, we covered some strategies to be more savvy with your tax-bracket management.
Non-Designated Beneficiaries
Charitable beneficiaries are the most common group that falls into the “non-designated beneficiaries” category. An even more limited five-year RMD window applies to this category of beneficiaries. The practical application for most of these beneficiaries is limited due to charities tax-exempt status (most take an immediate full distribution); however, certain trusts that do not qualify for more the more favorable treatments will be subject to the restrictive five-year distribution window.
Under the proposed regulations, this group would also be subject to a similar test for IRA owners who were subject to RMDs at the time of their death. Accordingly, they would have an annual computed RMD for years one-through-four and then a final RMD to deplete the Inherited IRA in year five. Beneficiaries who inherit a retirement plan where the original owner was not taking RMD’s would only be subject to a 100% distribution RMD in the fifth year.
Ultimately, once final regulations for the SECURE Act are adopted by the IRS, retirement plan owners will need to be mindful of the impact of how their beneficiary designations will be implemented. We encourage clients to revisit this topic with their portfolio manager and tax professionals ensuring that goals are aligned with their retirement plan beneficiary designations.
Ferguson Wellman, Octavia Group and West Bearing do not provide tax, legal, insurance or medical advice. This material has been prepared for general educational and informational purposes only and not as a substitute for qualified counsel. You should consult qualified professionals to understand how this information may, or may not, apply specifically to you.