By: Joseph Goldy, CFP®
Since President Trump signed the SECURE Act into law in 2019, questions have swirled around how to interpret some of the Act's provisions. To reduce confusion, the IRS recently released Proposed Regulations, which attempt to clarify the more ambiguous parts of the law. It should be noted that these Proposed Regulations can, and likely will, still change before the IRS releases any final interpretations.
There are several points to the Proposed Regulations. Here is a closer look at a few of the provisions most likely to affect our clients.
Non-Eligible Designated Beneficiaries
This group includes non-spouse beneficiaries (including children of the decedent age 21 and over) divided into two groups depending on when the account owner passed away. If the original account owner passed away before their Required Minimum Distributions started, the Non-Eligible Designated Beneficiary would be subject to the 10-Year Rule.
If the original account owner passed away after their Required Beginning Date, the Non-Eligible Designated Beneficiary would be subject to the 10-Year Rule and stretch distributions.
[Stretch distributions allow an IRA beneficiary the option to base their Required Minimum Distributions on their life-expectancy. Thus, allowing them to stretch the amount that needs to be withdrawn over a more extended period and leave more of the assets in the IRA getting the preferential tax deferral.]
For beneficiaries who fall into this category, they will be subject to regular annual withdrawals from the inherited IRA, taxed as ordinary income, and be required to empty the entire account by the end of the 10th year after the original account owner's death.
Defining Minor Children of Decedents
For minor beneficiaries of deceased retirement account owners, the age the IRS defines when they are no longer a minor is significant. Age is important because it determines if they are "Eligible Designated Beneficiary," allowing them to take advantage of stretch IRA distributions or a "Non-Eligible Designated Beneficiary" subject to the 10-Year Rule.
Before the Proposed Regulations were released, the Age of Majority would be determined by the person's state of residence, ranging from 18 to 21. Thankfully, the IRS clarified that 21 would be the universal age to determine when someone is no longer considered a minor for beneficiary classification purposes.
This decision means that a minor child beneficiary of a retirement account owner who died before reaching their Required Beginning Date would use stretch IRA distributions based on their life expectancy until age 21. Then, they would be required to follow the 10-Year Rule forcing them to empty the account within ten years.
If the original account owner had passed away after their Required Beginning Date, the beneficiary would also need to take regular annual distributions since they would be subject to the 10-Year Rule and stretch distributions.
Options for Eligible Designated Beneficiaries
Before the SECURE Act, Eligible Designated Beneficiaries (generally children or family members aged 21 and over) had the option to either stretch their RMDs over their life expectancy or empty the entire account within five years. The SECURE Act was unclear whether this option was still available, albeit with a ten-year window to deplete the account rather than over five years.
The answer is: Maybe.
According to the Proposed Regulations, the IRS says both the stretch and 10-Year distribution options will continue to be allowable for this beneficiary category. However, the IRS is leaving it up to the IRA custodians or plan providers to decide whether to allow the option or not.
As it stands now, depending on where an Eligible Designated Beneficiary holds their IRA will determine what distribution options are available. This interpretation is meaningful because having the 10-Year opportunity to let the assets grow on a deferred tax basis, without required annual withdrawals, is the optimal solution for many people.
We will monitor these proposals as time goes on and hopefully receive further clarification from the IRS. As with most things tax-related, expect more revisions to come. At Highland, we regularly review new tax legislation to determine how it impacts our clients. Please don't hesitate to reach out to your Wealth Advisor with any questions.
Joseph Goldy, CFP®, is a wealth advisor and CERTIFIED FINANCIAL PLANNER™ at Highland Financial Advisors, LLC, a fee-only fiduciary wealth advisory firm based in Wayne, New Jersey.
Joe specializes in working with newly independent women because of divorce or losing a spouse. He understands firsthand the value of having a clear financial picture pre- and post-divorce and a plan to restate goals as a single person. When he is not helping clients, Joe enjoys spending time with his two sons outdoors and volunteering to help raise money for Type 1 diabetes organizations.