Determining Beneficiary Options, Post-SECURE Act
By Lisa Haberman, MBA, MAM
Confused when it comes to determining beneficiary distribution options for IRAs and qualified retirement plans? Even more confused after the enactment of the Setting Every Community Up for Retirement Enhancement (SECURE) Act? Since the SECURE Act changes became effective, beneficiary distribution options depend on three primary factors: 1) the date of the account owner’s death, 2) the type of beneficiary, and, under some circumstances, 3) when the primary account owner died in relation to the required beginning date (RBD)—generally April 1 of the year following attainment of age 72—for withdrawing required minimum distributions (RMDs). Your financial organization will need to consider all three factors before making any distributions to IRA or retirement plan beneficiaries.
NOTE: Roth IRAs do not have RMDs, but the Traditional IRA RBD applies equally to Roth IRAs for purposes of beneficiary distribution options.
Date of Account Owner’s Death
The SECURE Act provisions affect beneficiary distributions when the account owner died on or after January 1, 2020. The year of the account owner’s death—not the year your organization was notified of the death—is the determining factor for which set of distribution options (pre-SECURE Act or post-SECURE Act) is available to a beneficiary.
Type of Beneficiary
If the account owner died on or after January 1, 2020, the beneficiary distribution options follow post-SECURE Act rules and depend on the type of beneficiary. The SECURE Act added “eligible designated beneficiary” as a type of beneficiary, which can be a named individual or nonperson beneficiary.
Who is considered an “eligible designated beneficiary?” The surviving spouse of a deceased account (IRA or retirement plan) owner is an eligible designated beneficiary, along with the nonspouse beneficiary categories of minor children of the account owner, disabled persons, chronically ill individuals, and individuals not more than 10 years younger than the deceased account owner. Both spouse and nonspouse eligible designated beneficiaries may select annual life expectancy (or greater) payments, follow the new 10-year rule for taking distributions, or take a lump sum distribution. Spouse eligible designated beneficiaries are also allowed to transfer or distribute and roll over to an IRA of their own, regardless of the account type inherited from the deceased spouse.
One of the most significant changes the SECURE Act made was to eliminate life expectancy payments as a distribution option for “designated beneficiaries,” the broad category of individuals who are not “eligible designated beneficiaries.” Before the SECURE Act, nonspouse beneficiaries, including adult children, were able to stretch their distributions and related tax obligations over their life expectancies. Post-SECURE Act, designated beneficiaries are limited to the 10-year rule, which requires beneficiaries to withdraw the entire balance of the account by December 31 of the year that includes the 10th anniversary of the account owner’s death.
The 10-year rule as described in IRS Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs), created confusion over whether required distributions need to be made in each of the 10 years, or if a beneficiary may take random distributions, or delay withdrawing the entire balance of the account until the final year. The IRS recently revised Publication 590-B, making clear that a beneficiary is allowed, but not required, to take a distribution before December 31 of the year containing the 10th anniversary of the IRA owner’s or plan participant’s death. What was not clear, and for which IRS clarification is needed, was the unexpected implication—unsupported, so far as Ascensus has determined—that if death occurs after an IRA owner’s RBD, the 10-year option may not be used by an eligible designated beneficiary.
When Account Owner Died in Relation to RBD
Life Expectancy Payments for Eligible Designated Beneficiaries
If an eligible designated beneficiary (spouse and nonspouse) elects life expectancy payments as a distribution option and the account is not a Roth IRA, it is important to determine if the original account owner died before or on or after her RBD for beginning distributions. (Remember, life expectancy payments are no longer an option post-SECURE Act for designated beneficiaries.)
If the account owner died before the RBD, or if it is a Roth IRA—regardless of the deceased account owner’s age—then eligible designated beneficiaries, both spouse and nonspouse, have the option to start life expectancy payments by December 31 of the year following the year the account owner died. Spouse eligible designated beneficiaries also have the option to delay taking a life expectancy distribution until December 31 of the year the account owner would have turned age 72.
If the account owner died on or after his RBD, each beneficiary is required to receive his or her attributable portion of the account owner’s RMD from a non-Roth IRA or retirement plan for the year of the account owner’s death if it has not yet been satisfied. Both spouse and nonspouse eligible designated beneficiaries must begin their own life expectancy withdrawals by December 31 of the year following the year the account owner died.
Note that a spouse beneficiary, however, has the right to treat an inherited account as her own if it’s an IRA or to roll the assets over to her own IRA if inheriting an employer-sponsored retirement plan account.
Nonperson Beneficiaries
Nonperson beneficiaries are entities, or beneficiaries that are not individuals, such as a charitable organization or an estate or trust. The SECURE Act generally did not change the options for these beneficiaries. In cases where a nonperson beneficiary is listed, or no beneficiary is listed, and the governing document defaults to a nonperson—typically an estate—the distribution options will depend on whether the account owner died before or on or after reaching the RBD. While the lump sum distribution option is available in both scenarios, the five-year rule will apply when the account owner died before reaching the RBD. The five-year rule allows nonperson beneficiaries to withdraw any amount at any time as long as the entire balance is depleted by December 31 of the year containing the fifth anniversary of the account owner’s death. Life expectancy payments—based on the remaining life expectancy of the decedent—is the option available for nonperson beneficiaries if the account owner died after reaching the RBD. Distributions must start by December 31 of the year following the account holder’s death.
More to Come?
While these options are believed to be an accurate reflection of changes contained in the SECURE Act, the IRS has promised to issue SECURE Act regulatory guidance. But can we expect it in the near future? Will it contain any surprises?
Finally, keep in mind that the beneficiary distribution options in the IRA plan agreement or retirement plan document may be more restrictive than what was just discussed, but cannot be more generous.
