The Setting Every Community Up for Retirement Enhancement (SECURE) Act, passed in December 2019, introduced a wide range of reforms aimed at improving access to retirement savings and updating outdated policies. One of the most significant changes impacts the way distributions are handled for retirement accounts inherited after 2019. If you’ve inherited a 401(k), IRA, or other retirement account in recent years, it’s crucial to understand how the SECURE Act has altered the rules.
Key Changes to Inherited Retirement Accounts Under the SECURE Act
Prior to the SECURE Act, non-spouse beneficiaries of inherited retirement accounts could take required minimum distributions (RMDs) over their own life expectancy—a strategy commonly referred to as a “stretch IRA.” This allowed them to spread withdrawals and tax liabilities over decades, preserving more of the account’s growth potential. However, the SECURE Act has changed this significantly for most beneficiaries.
1. Introduction of the 10-Year Rule
The SECURE Act eliminated the “stretch IRA” option for many non-spouse beneficiaries and replaced it with a 10-year rule. Under this new rule, beneficiaries must withdraw the entire balance of the inherited retirement account within 10 years of the original account holder’s death.
- There are no required annual distributions under the 10-year rule. Instead, the beneficiary has flexibility in how and when to take distributions within the 10-year window. This allows for some tax planning opportunities, but failure to withdraw the entire balance by the end of the 10th year can result in hefty penalties.
- This change means that beneficiaries must be more proactive in managing their tax liabilities, as taking large distributions in later years could result in a higher tax bracket.
2. Exceptions for Eligible Designated Beneficiaries (EDBs)
The SECURE Act does, however, provide exceptions for certain types of beneficiaries, known as Eligible Designated Beneficiaries (EDBs), who can still take distributions over their life expectancy. These EDBs include:
- Surviving spouses: Spouses can continue to take RMDs based on their life expectancy or roll the account into their own retirement plan.
- Minor children of the account owner: Minor children (but not grandchildren) can take distributions over their life expectancy until they reach the age of majority, at which point the 10-year rule kicks in.
- Disabled individuals: Individuals who are considered disabled under IRS guidelines can take distributions over their life expectancy.
- Chronically ill individuals: Those with chronic illnesses can also spread withdrawals over their life expectancy.
- Beneficiaries within 10 years of the decedent’s age: If the beneficiary is not more than 10 years younger than the deceased account holder, they may also continue taking RMDs based on life expectancy.
These exceptions provide some flexibility for beneficiaries who may face significant financial or health challenges.
3. Impact on Roth IRAs
The SECURE Act’s 10-year rule also applies to inherited Roth IRAs. While Roth IRA withdrawals are generally tax-free (as long as the account has been open for at least five years), beneficiaries must still deplete the account within the 10-year period. Roth beneficiaries have the advantage of being able to delay withdrawals until the end of the 10-year window without incurring tax penalties, allowing the assets to grow tax-free for as long as possible.
4. Tax Considerations and Estate Planning Implications
The introduction of the 10-year rule has significant tax implications. Without the ability to stretch distributions over a lifetime, beneficiaries may face higher taxes if they do not strategically plan their withdrawals. For example, spreading distributions out over several years may help avoid moving into a higher tax bracket. Beneficiaries should also consider the timing of withdrawals in relation to other income sources.
In response to these changes, estate planning strategies may need to be revised. For example:
- Charitable Remainder Trusts (CRTs): Some account holders are turning to CRTs as a way to replicate the tax benefits of the old stretch IRA rules. By leaving retirement accounts to a CRT, beneficiaries can receive regular income payments, and any remaining assets at the end of the trust’s term go to charity.
- Roth Conversions: Account holders may want to consider converting traditional IRAs to Roth IRAs during their lifetime to alleviate some of the tax burdens for their beneficiaries. While Roth conversions trigger a tax liability at the time of conversion, they can potentially reduce the overall tax burden for beneficiaries.
Conclusion
The SECURE Act’s changes to the rules for inherited retirement accounts represent a significant shift, particularly for non-spouse beneficiaries. The elimination of the stretch IRA and the introduction of the 10-year rule have created new tax considerations and estate planning challenges. Beneficiaries must now take a more active role in managing inherited accounts to minimize taxes and maximize the growth of their assets.
If you have inherited or expect to inherit a retirement account, it’s a good idea to consult with a financial advisor or tax professional to understand how the new rules apply to your situation and to develop a strategy that aligns with your long-term financial goals.