NO DOUBT, you’ve been reading about the SECURE Act’s impact on retirement accounts. The SECURE Act was passed in December. Regulations have not been issued as of yet, so be sure to talk with your attorney or accountant before taking any action.
A bit of controversy is brewing about one provision that affects post-death required minimum distributions for nonspouses — RMDs that are mandated after the employee (in the case of a company plan) or owner of the account (if an IRA) dies.
Let’s take a pre-SECURE Act example. An IRA owner’s beneficiary designation form named his grandchild as his IRA beneficiary. When the owner died, the IRA was retitled as an inherited IRA for the benefit of the grandchild. No matter the grandchild’s age (even if the grandchild was age 2), the inherited IRA was subject to RMDs that would extend many years over the grandchild’s life expectancy. Thus, the grandchild could “stretch” out mandated withdrawals and, in turn, allow continued tax-deferred growth of the retirement account.
The SECURE Act, which is now in effect, places a severe limit on the ability to stretch tax deferral beyond the IRA owner’s lifetime. In this example, the grandchild’s stretch would be limited to 10 years. (Before, the 2-year-old’s deferral period could last more than 80 years.)
If the IRA owner dies in 2020, the grandchild’s inherited IRA must be distributed in full by the end of the 10th calendar year following the year of the IRA owner’s death. If it is not fully withdrawn by then, there would be a 50% penalty on the amount that should have been withdrawn but was not. There is no requirement that RMDs be satisfied yearly over the 10-year period.
The 10-year period also applies to inherited Roth IRAs. Beneficiaries are not taxed on those withdrawals, but they are now required to bring those Roth balances down to zero much faster than under pre-SECURE Act law.
But of course, legislators are loath to keep things simple. There are exceptions to the 10-year rule. They fall under a new category of beneficiary called an “eligible designated beneficiary” (EDB).
Whether someone is an EDB is determined as of the date of death of the employee or IRA owner. EDBs can continue the pre-SECURE Act stretch.
So, who are EDBs? In addition to the surviving spouse, a minor child is an EDB, but only until the minor reaches majority. Then, “any remainder of the portion of the individual’s interest ... shall be distributed within 10 years after such date,” quoting from the statute.
A “disabled” or “chronically ill” individual is also an EDB, with some limitations set out in the statute, as well as an “individual not described in any of the preceding subclauses who is not more than 10 years younger than the employee.”
These changes raise some practical questions and create the need to review beneficiary designations and estate plans. For those who want to benefit from longer tax-deferral periods, most will likely want to name their spouses as their beneficiaries. If you have a trust as beneficiary, you’ll definitely want your lawyer to review the effect of the SECURE Act on mandated deferrals.
I participated in a webinar given by attorney Natalie Choate the other day, and I can tell you that the new law requires a careful review, even if you have a carefully crafted conduit trust. Choate is the author of “Life and Death Planning for Retirement Accounts.”
Also, I encourage readers of this column to write to me with questions and comments. When you do, please be sure to tell me where you read the column and the state you live in. My email is email@example.com.
On a completely different note, as a proponent of financial literacy education, I have a special interest in promoting investing for retirement, especially among young employees who have access to company retirement plans, such as 401(k)s.
If you know of any participants who take part in the benefits of their 401(k)s at work, tell them to apply for the 401(k) Champion Award. The award shines a light on participants who “love” their 401(k)s. For rules and deadlines, go to juliejason.com/award.