Starting with the SECURE Act of 2019—and continuing with the SECURE Act 2.0 and proposed and final required minimum distribution (RMD) regulations—the rules for IRA beneficiaries have changed considerably. These changes may affect how IRA owners structure their beneficiary designations and how beneficiaries are required to withdraw inherited IRA assets. The new rules are extensive, but the following highlights will give you and your beneficiaries a good framework for understanding distribution options. In addition, STRATA provides great resources for those seeking more detail.
Not Many Changes for Spouse Beneficiaries
Many married IRA owners will name their spouse as the primary beneficiary of their IRAs. In some states, in fact, spouses must consent if the IRA owner names someone else as the primary beneficiary. Fortunately, spouse beneficiaries continue to have the full complement of distribution options available to them when the IRA owner dies.
- Treat the IRA as the spouse beneficiary’s own IRA. This is the most common option that spouses choose. Once the decedent’s IRA assets are transferred or rolled over to the spouse’s IRA, the regular IRA rules apply instead of the inherited IRA rules. But if the spouse beneficiary is under age 59½, keeping the assets in an inherited IRA may make sense because distributions would not be subject to an early distribution penalty.
- Take life expectancy payments. Taking at least annual distributions over the longer of the decedent’s or the beneficiary's life expectancy is also an option. This “stretch IRA” election has changed little from the method that we’ve practiced for decades. Sometimes spouse beneficiaries under age 59½ will choose this option—and then will take the remaining IRA assets as their own upon reaching 59½.
- Elect the 10-Year Rule. If the IRA owner passes before the required beginning date for mandatory distributions, the spouse beneficiary may elect the 10-Year Rule. (This option also applies to Roth IRA beneficiaries, no matter when the Roth IRA owner passes.) This rule is straightforward: the beneficiary must simply deplete the entire IRA by the end of the year that contains the tenth anniversary of the IRA owner’s death.
At any time, beneficiaries may withdraw more than is required, up to taking a lump-sum payment. Important tax consequences may attach to each of these options, so all beneficiaries should seek sound advice before making any election.
Non-spouse Beneficiaries That Are “EDBs”
The final RMD regulations contain a definition of an eligible designated beneficiary or EDB. EDBs are individuals who are:
- Married to the IRA owner when the owner dies,
- Minor children of the IRA owner,
- Disabled or chronically ill, or
- Not more than 10 years younger than the IRA owner.
Non-spouse beneficiaries who are EDBs determine their options based on whether the IRA owner passed before, on, or after the required beginning date. This date is April 1 following the first year for which the IRA owner must take an RMD. (Because Roth IRAs are not subject to RMDs during the owner’s lifetime, Roth IRA beneficiaries use the options that are available when death occurs before the required beginning date.)
Generally, non-spouse EDBs—like spouse EDBs—may use the stretch IRA option. In other words, they may take annual distributions over their single life expectancy. Alternatively, if the IRA owner passes before the required beginning date, such beneficiaries can choose the 10-Year Rule. Many beneficiaries like the idea of taking smaller required annual payments based on life expectancy, but there are situations in which the 10-Year Rule may be preferable.
Beneficiaries That Are Not EDBs - "DBs"
All individual beneficiaries that do not fall into the EDB definition above are considered designated beneficiaries, or DBs. This category of beneficiaries is subject to the biggest change, which was brought about by the SECURE Act of 2019. DBs must deplete the inherited IRA assets under the 10-Year Rule. Additionally, if the IRA owner has passed after the required beginning date, then during the first nine years of this period, annual distributions must be taken, generally based on the single life expectancy of the beneficiary. This rule—requiring account depletion within 10 years—was designed to boost revenue to pay for other provisions in the SECURE Act.
Non-Person Beneficiaries
IRA owners may name non-person entities as beneficiaries. Such entities include charities, estates, or trusts that do not qualify as see-through trusts. With these beneficiaries, the distribution requirements mirror those that were in effect before the enactment of the SECURE Act. If the IRA owner passes before the required beginning date, the 5-Year Rule applies. That is, the beneficiary must deplete the account by the end of the year that contains the fifth anniversary of the IRA owner’s death. If the IRA owner passes on or after the required beginning date, annual payments must be taken based on the IRA owner’s remaining life expectancy.
Quick Guide: Beneficiary Distribution Options
More to Come
This summary of beneficiary options is not exhaustive —there are numerous twists and turns that could affect how beneficiaries are treated. For example, qualified see-through trusts are treated more generously than other trusts. We will explore some of these different rules in future articles. For more information regarding today’s topic, you can review our Quick Guide: Beneficiary Distribution Options shown above or visit our FAQ section, What Do IRA Beneficiaries Need to Know? As always, although STRATA does not provide any investment advice, our IRA experts are available to help you understand your beneficiaries’ options and to guide you through the beneficiary designation process—feel free to contact us.
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