SECURE Act Proposed Regulations Impact 10 Year IRA Distribution Rule Bigly!

One of the biggest changes made by the SECURE Act was the imposition of a 10 year distribution rule for certain IRA (and other defined contribution-type retirement account) beneficiaries. This 10 year rule applies when the IRA owner dies after December 31, 2019. Under the new 10 year rule, most non-spouse IRA beneficiaries must withdraw the entire balance of an inherited IRA within 10 years of the year of the account owner’s death.

(If the account owner died before January 1, 2020, the old and familiar lifetime distribution rules still apply and allow a beneficiary to take distributions from an inherited IRA over her remaining life expectancy.)

The 10 year rule itself seemed straightforward. When the rule was enacted, commentators and practitioners (myself included) believed that an IRA beneficiary had the choice to delay liquidating the inherited IRA until the end of the 10th year, or take distributions at any time during the 10 year period as long as the entire account balance was liquidated before the end of the 10th year.

However, the proposed regulations introduce a significant wrinkle to the 10 year rule that will impact a great number of IRA beneficiaries. Under the proposed regulations, the IRA beneficiary must take required minimum distributions (RMDs) from the inherited IRA during the 10 year period if the IRA owner died on or after their required beginning date (RBD). In other words, if the account owner was subject to RMDs at the time of his death, then the designated IRA beneficiary must take an annual distribution from the inherited IRA beginning with the year following the year of the account owner’s death. The amount of the annual RMD will be calculated using the beneficiary’s remaining life expectancy, reduced by one for each subsequent calendar year during the 10 year term, with the remaining balance withdrawn before the end of the 10th year.

If the IRA owner died before his RBD, then the IRA beneficiary will be subject to the 10 year distribution rule, but not the additional RMD rules.

Let’s look at a couple of examples:

Death before RBD — John is the 30 year old son of IRA owner William and the beneficiary of William’s IRA. William dies in August 2022 at the age of 55. Since William died before his RBD (April 1 following the year William would have reached age 72), John is subject to the 10 year liquidation rule and must simply withdraw the entire balance of William’s IRA before December 31, 2032, the 10th year following William’s death. John is not required to take an annual minimum distribution during the 10 year term.

Death after RBD — IRA owner William dies in August 2022 at the age of 73. John, William’s 50 year old son, is the beneficiary of William’s IRA. Since William died after his RBD (after April 1 of the year following the year William turned age 72), John is subject to both the 10 year liquidation rule, and the applicable RMD rules. So beginning in 2023 John must calculate a required minimum distribution based upon his remaining life expectancy for years 1 through 9 of the 10 year term, and withdraw the entire remaining balance by the end of year 10.

But what about Roth IRA beneficiaries you ask? The proposed regulations confirm that all deceased Roth IRA owners are deemed to have died before their required beginning date (because Roth IRA owners are exempt from taking required minimum distributions). Therefore, if a Roth IRA owner dies after December 31, 2019, her account beneficiary will only be subject to the 10 year distribution rule. This will allow for an additional 10 years of tax free growth before a distribution needs to be taken.

The rules governing distributions from IRAs and other retirement accounts have always been complex. The proposed regulations (if and when adopted) will only add to the complexity. You should work with an qualified advisor who can help you avoid all of the potential tax traps that await the unwary.

If you are not sure how the rules may apply to your situation, give us a call, we can help.