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Aug 18, 2020

Big Changes for Beneficiaries Beginning in 2020

The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 was generally designed to provide workers with more opportunities to save in a workplace plan and to help individuals save more – for longer – in retirement plans and IRAs. One provision of the SECURE Act, however, has the opposite effect by forcing people to take tax-deferred retirement savings out faster than required before. A provision that changes the payment options available to beneficiaries was included as a “revenue raiser,” meaning it will help to potentially offset the tax cost of some of the other SECURE Act provisions that increase tax credits and tax deferral opportunities. The new beneficiary distribution rules eliminate the “stretch IRA” strategy for most beneficiaries. Now, inherited assets will typically be required to be distributed within 10 years, which results in paying taxes sooner on those tax-deferred retirement savings.

Under the stretch IRA strategy, a beneficiary elects to take payments under the life expectancy payment option and must withdraw at least a minimum amount each year. The minimum payment is calculated using a life expectancy factor specified in the IRS’s Single Life Expectancy Table. Beneficiaries can always withdraw more than the minimum required, but by taking only the minimum amount each year, they are able to reduce the tax impact of their inheritance and allow the assets to continue growing tax-deferred for a longer period of time. In some cases, this strategy could be used to pass on inherited assets to multiple generations. This strategy is no longer an option for certain beneficiaries.

 

Simplified Beneficiary Options

Although some perceive the SECURE Act changes as negatively affecting beneficiaries, the changes at least simplify this complex area of tax law. Under the old rules, the options available to a beneficiary depended on whether the IRA owner had died before or after their starting date for taking required minimum distributions (RMDs), the type of IRA (Roth or traditional), and the relationship of the beneficiary to the IRA owner. Now, the options available to a beneficiary are dictated by the beneficiary’s relationship to the IRA owner (and in some cases the beneficiary’s age and health status).

Beneficiary distribution options for traditional and Roth IRAs can now be segmented into three categories:

 

1. Eligible Designated Beneficiary (EDB)

A beneficiary who meets the requirements to be an eligible designated beneficiary (EDB) retains the option to take life expectancy payments from the inherited IRA (i.e., the stretch IRA strategy). If they choose not to take annual life expectancy payments, they must deplete the inherited IRA within 10 years. A spouse beneficiary also retains the right to treat the IRA as their own or roll the inherited assets to their own IRA or retirement plan.

• An EDB is any of the following types of beneficiaries:

• Surviving spouse of the IRA owner

• Child of the IRA owner who has not reached the age of majority

• Disabled individual (generally, unable to engage in substantial gainful activity due to physical or mental impairment, likely to be of long duration)

• Chronically ill individual (generally, unable to perform at least two of six activities of daily living for an indefinite and lengthy period)

• Non-spouse beneficiary who is not more than 10 years younger than the IRA owner

 

2. Person Who Is Not an EDB

A person who is not included in the list of EDBs (e.g., siblings, adult children) must deplete an inherited IRA by the end of the 10th year following the year of death. Although they no longer have the option to stretch out the tax deferral of the inherited assets over their lifetime, they do have 10 years in which to spread the distributions (and resulting taxation). They also have the option to wait until the 10th year and take a lump-sum distribution from the IRA. Under the old rules, a beneficiary who did not choose to take annual life expectancy payments had to deplete the inherited IRA within five years.

 

3. Non-Human Beneficiary

The options for non-human beneficiaries, such as estates, trusts, and charities, remain the same as they did prior to the SECURE Act.

• If death occurs before the IRA holder’s RMD starting date, the beneficiary must deplete the inherited IRA within five years following the year of death.

• If death occurs after the RMD starting date, the beneficiary may take annual life expectancy payments over the remaining life expectancy of the IRA holder.

These SECURE Act changes apply to beneficiaries of IRA owners who died on or after January 1, 2020. Beneficiaries who inherited retirement savings prior to 2020 are subject to the pre-SECURE Act rules for determining their beneficiary distribution options.

 

More to Come

The new rules as explained in this blog are based on current interpretation of the statutory language in the SECURE Act. The retirement plan industry awaits additional guidance from the Treasury Department to clarify certain details related to these changes.

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