New 10-Year Rule for Beneficiaries Comes with New Considerations
By Jeff Aga, CPC, TGPC, CISP, CHSP
What SECURE Act change most affected inherited retirement accounts?
The Setting Every Community Up for Retirement Enhancement (SECURE) Act, part of the Further Consolidated Appropriations Act, 2020, enacted in December 2019, made significant changes to the rules on how beneficiaries of inherited retirement accounts distribute their inherited assets. Of greatest significance is that most nonspouse beneficiaries can no longer “stretch out” their distributions and, therefore, the taxation over their life expectancies.
Before the SECURE Act, nonspouse beneficiaries were allowed to take distributions based on their own life expectancies by withdrawing required minimum amounts (RMDs) annually. For example, a 48-year-old beneficiary has a life expectancy of 36.0 (according to the IRS’ Single Life Expectancy Table), permitting that beneficiary to stretch out the distributions and taxation for 36 years. Now, if the account owner died in 2020 or a later year, most nonspouse beneficiaries will be required to deplete the inherited account within 10 years after the account owner’s death. This is commonly referred to as “the 10-year rule.”
Do all nonspouse beneficiaries have to use the 10-year rule?
The SECURE Act identifies three groups of beneficiaries. Individuals are either “designated beneficiaries” or “eligible designated beneficiaries.” “Eligible designated beneficiaries” are the spouse of the deceased account owner, minor children of the deceased account owner, those who are disabled or chronically ill, and those who are not more than 10 years younger than the deceased account owner. Eligible designated beneficiaries do not have to use the 10-year rule, and may elect to take distributions over their single life expectancy.
But a “designated beneficiary” of an account owner who died on or after January 1, 2020, is subject to the 10-year rule, and must deplete the account by December 31 of the 10th year following the original account owner’s death.
The third group of beneficiaries is considered nondesignated, or a nonperson, such as an estate or a charity, and remains subject to the five-year rule: it must distribute the inherited retirement assets within five years.
Are there any benefits to the 10-year rule?
The 10-year rule gives beneficiaries flexibility in the timing of distributions, as it does not require annual distributions as the life expectancy method does. Under the single life expectancy distribution rules, if an annual distribution is missed, the beneficiary is subject to a 50 percent tax on the “excess accumulation” that remains in the retirement account, (i.e., the missed RMD). Under the 10-year rule, assets may be distributed in any amount at any time as long as the entire amount is withdrawn by the end of the 10th year. This allows beneficiaries the option of either taking distributions every year for 10 years, taking them intermittently as they wish, or letting the inherited account grow for 10 years and taking one large distribution in the 10th year.
The options and combinations of taking distributions under the 10-year rule are endless. Beneficiaries should discuss what would work best for them with their tax professionals.
Are there any special distinctions about the 10-year rule to be aware of?
Eligible designated beneficiaries who are minor children of the deceased account owner are able to start taking life expectancy payments in the year following the year of death. Once the child reaches the age of majority (presumably age 18), the child then becomes subject to the 10-year rule and must distribute the remaining assets within the next 10 years.
EXAMPLE
Tony is a single father who has named his 10-year-old daughter, Samantha, as the sole beneficiary of his Traditional IRA. Sadly, Tony dies in a car accident at age 40, leaving Samantha to inherit his IRA. Under the single life expectancy rules, Samantha generally must begin taking annual distributions at age 11 and continue until age 18 when she reaches the age of majority. Once Samantha turns age 18, the 10-year rule takes effect and she will need to deplete the inherited IRA over the next 10 years, the year in which she reaches age 28.
