I’ve talked about the Secure Act before in this column, but a lot of my clients come to me with questions about how 2.0 will impact their beneficiaries so it bears a more detailed discussion.
What are the changes to the Secure 2.0 IRA?
Under the law before SECURE 2.0, you generally had to take required minimum distributions (RMDs) from your retirement plan beginning at age 72. SECURE 2.0 increased the required minimum distribution age to 73 as of January 1, 2023. However, if you turned 72 in 2022, you still had to take your first RMD by April 1, 2023. And, starting in 2033, the age at which RMDs must start to be taken will be pushed back again to age 75.
The penalty for failing to take an RMD will decrease to 25% of the RMD amount, from 50% currently, and 10% if corrected in a timely manner for IRAs.
Does SECURE 2.0 change the RMD calculation for my existing inherited IRA?
Under SECURE 2.0, the RMD rules for existing inherited IRAs left to beneficiaries remain unchanged, unless you've inherited a special needs trust.
What is the new 10-year beneficiary rule?
Prior to the act, if you inherited an IRA or 401(k), you could generally "stretch" your taxable distributions and tax payments out over your life expectancy. Many people used "stretch" IRAs and 401(k)s as a reliable lifetime income source. The SECURE Act requires the entire balance of the participant's inherited IRA account to be distributed or withdrawn within 10 years of the death of the original owner, and the beneficiary is required to pay the resulting tax liability.
So, what does this mean?
Beneficiaries of account owners must distribute the account balance by December 31 or the tenth year following the year the IRA owner dies but are not required to distribute money in years one through nine.
If the owner of the account dies after having started taking RMDs, the IRS states that the beneficiary of the account must continue to take RMDs based on THEIR single life expectancy table, rather than that of the decedent’s, fully depleting the account by end of year 10.
Are there any exceptions?
Of course! There are exceptions to the 10-year rule, depending on which category the beneficiary falls into. And spouses inheriting an IRA have a much broader range of options available to them.
What are the three categories of beneficiaries under the SECURE Act?
Eligible Designated Beneficiaries (EDB)
- a surviving spouse
- a disabled or chronically ill individual – determined at the time of death of the IRA owner
- an individual who is not more than 10 years younger than the IRA owner, based on birthdates not tax years
- a child of the IRA owner who has not reached the age of majority, meaning age 21
For those who fall into this category, the stretch option still applies.
Designated Beneficiaries (DB)
- non-spouses
- certain trusts
The 10-year rule applies to designated beneficiaries.
Non-Designated Beneficiary (NDB)
- Charities
- Your estate (naming your will)
- certain trusts
For this category, there is a 5-year rule which stipulates that the beneficiary must take out the remaining balance of the retirement account over the five-year period following the owner's death. There is no RMD in any one year, but the account must be fully depleted by December.
Planning Ideas
Leveraging tax brackets between IRA owners and their beneficiaries is more important than ever due to the changes above, and IRA owners should consider whether or not a Roth conversion makes sense for them.