Last December, the imaginatively named Setting Every Community Up for Retirement Enhancement (SECURE) Act became law.
Ernie Neve, CPA
October 1, 2020
The SECURE Act was intended mainly to expand opportunities for individuals to increase their retirement savings and to simplify the administration of retirement plans. Fine. Good.
But the act also included a big unfavorable change that kneecapped the so-called stretch IRA estate planning strategy that was employed by well-off IRA owners.
The Stretch IRA Strategy
The stretch IRA strategy involves keeping as much money as possible in your traditional IRA or Roth IRA while you’re still alive and then leaving the account to your spouse or a younger beneficiary, who keeps the inherited account rolling for as long as possible and keeps collecting the tax benefits. Thus, the term “stretch IRA.”
The SECURE Act Imposes a New 10-Year Account Liquidation Rule That Seriously Injures the Stretch IRA Strategy
Unfortunately for the estate plans of well-off IRA owners and the tax situations of some of their IRA beneficiaries, the SECURE Act requires most non-spouse beneficiaries to drain inherited IRAs within 10 years after the account owner’s death.
As we just explained, the pre–SECURE Act required minimum distribution (RMD) rules allowed a non-spouse IRA beneficiary to gradually drain the substantial traditional or Roth IRA inherited from good-ole Grandpa Frank over the beneficiary’s IRS-defined life expectancy. That deal is off the table if Grandpa Frank dies in 2020 or later.
Who Is Affected by the SECURE Act Change?
The SECURE Act’s anti-taxpayer 10-year account liquidation rule doesn’t affect RMDs taken by original traditional IRA owners. They still operate under the same RMD rules as before.
As under pre–SECURE Act law, original owners of Roth IRAs need not take any RMDs for as long as they live. They are unaffected.
Beneficiaries who want to quickly drain their inherited IRAs are unaffected.
Bottom line. The 10-year account liquidation rule affects only certain non-spouse beneficiaries who would otherwise keep inherited accounts open for as long as possible to reap the tax advantages.
Exception for Eligible Designated Beneficiaries
The SECURE Act’s 10-year account liquidation rule does not immediately affect accounts inherited by a so-called eligible designated beneficiary.
An eligible designated beneficiary is
the surviving spouse of the deceased account owner,
a minor child of the deceased account owner,
a beneficiary who is no more than 10 years younger than the deceased account owner, or
a disabled or chronically ill individual.
Under the exception for eligible designated beneficiaries, RMDs generally can be taken from the inherited account over the life expectancy of the eligible designated beneficiary, beginning with the year following the year of the account owner’s death.
Other non-spouse beneficiaries, whom we will call affected beneficiaries, will be slammed by the 10-year account liquidation rule.
Following the death of an eligible designated beneficiary, the account balance must be distributed within 10 years.
The account balance must be distributed within 10 years after a child of the account owner reaches the age of majority under local law.
10-Year Account Liquidation Rule Specifics
When applicable, the 10-year account liquidation rule generally applies regardless of whether you, as the original account owner, die before or after your RMD beginning date. Thanks to another SECURE Act change, the RMD rules do not kick in until age 72 if you attain age 70 1/2 after 2019. If you are in that age category, your required beginning date is April 1 of the year following the year during which you attain age 72.
And then, again thanks to the other SECURE Act change, an affected beneficiary must drain the account inherited from you by the end of the 10th calendar year following the year of your demise. Until that deadline is reached, your beneficiary can leave the account untouched.
Failure to comply with the 10-year account liquidation rule will expose the affected beneficiary to a penalty equal to 50 percent of the account balance that remains after the 10-year deadline has passed.
Reminder. As stated earlier, the SECURE Act’s 10-year account liquidation rule applies only to affected beneficiaries who inherit IRAs from original account owners who die after 2019. An IRA inherited by a non-spousal beneficiary from an original account owner who died in 2019 or earlier is unaffected, so the inherited account can still work as a stretch IRA, the same as before the SECURE Act.