It’s been over two years since the original Setting Every Community Up for Retirement Enhancement (SECURE) Act was enacted, and some Individual Retirement Arrangements (IRA) beneficiaries still struggle with navigating their accounts to minimize associated taxes and plan ahead.
Prior to the 2019 SECURE Act, IRA beneficiaries had something called a “Stretch IRA”. This is an option that allowed them to “stretch” their payouts across their life expectancy. It also allowed them to minimize and delay withdrawals from the inherited IRAs, thereby reducing taxes and keeping the money invested longer.
But the SECURE Act did away with that option. Now, the best way to make your IRA payouts last longer is by working with a financial advisor to understand the complex new rules and formulating strategies that may offer better planning opportunities. These include the 5 and 10-year rules, type of beneficiary, and Roth IRAs. By working with an experienced advisor who can cater a plan to suit your specific situation, you can still make the most of your IRA.
The 5-year rule
The 5-year rule is utilized in the event that the decedent fails to name beneficiaries on the IRA documents and passes away before their required beginning date.
The rule applies to non-designated beneficiaries like an estate, a non-qualifying trust, and a charity. Under the 5-year rule, the said account must be distributed by December 31st of the year containing the fifth anniversary of the original IRA creator’s death. While the distributions can be made, they are not mandatory in the first four years.
The 10-year rule
The regulations around the SECURE Act have caused some confusion for beneficiaries, especially regarding the 10-year rule. According to the new regulations, a beneficiary does not have an option to stretch the IRA distributions if they are not considered an eligible designated beneficiary. The 10-year rule requires all funds available in the inherited IRA to be withdrawn by the end of the 10th year following the original account owner’s death.
However, there is a crucial distinction if the account owner succumbed before or after the stated beginning date. You are not subject to a required minimum distribution (RMD) if you inherit the IRA before the required beginning date. Just ensure you deplete the funds in the account by the end of the 10th year after the original account owner’s death.
Conversely, you are subject to RMDs in the first nine years of inheritance if the original IRA owner dies after the required beginning date. Still, you must withdraw the balance by the end of the 10th year. Since you can use your life expectancy in this situation, you don’t have to withdraw as much as the original account owner.
The spouse’s advantage as a beneficiary
The 10-year rule does not restrict a surviving spouse who is an IRA beneficiary. The spouse enjoys the same options they had before the enactment of the SECURE Act. As a surviving spouse, you have several options to make your IRA payments as long-lasting as possible, including treating the inherited account as a regular IRA or rolling over the inherited IRA to an IRA in your name.
You can roll over the IRA in your name as a new or existing IRA, also known as getting a “fresh start” IRA. The strategy allows you to treat the inherited IRA as though it has been yours, name beneficiaries to the inherited IRA, and take RMDs without referring to the deceased spouse’s IRA.
Since you use the old rules for the inherited IRA, you can use the stretch IRA option while receiving RMDs throughout your life expectancy. However, if you are under 59 and a half years old, you should consider keeping the account in an inherited IRA to avoid the extra 10% penalty.
Roth IRAs are not subject to the RMDs, hence they don’t need beginning dates despite the account owner’s age at the time of death. Yet, they are still under the 10-year rule. So, if you’re a designated beneficiary, you must deplete the account balance by the end of the 10th year. On the other hand, non-designated beneficiaries are subject to the 5-year rule.
Some common mistakes and how to avoid them
Individuals make several mistakes when it comes to IRA inheritance. Some of the common mistakes include:
Assuming the 10-year rule applies to all beneficiaries
Despite what you’ve been told as a beneficiary, you should not assume that the 10-year rule applies to all beneficiaries. The rule is only effective when the original IRA account owner passes way after 2019. So, if you inherited the IRA before 2020, you could enjoy old regulations, including stretch IRA. Ensure you confirm with your financial advisor if you are exempt from the 10-year rule.
Failing to list a beneficiary
One of the most common mistakes people make when opening an IRA is failing to list beneficiaries. So, ensure that you list one or more beneficiaries for your IRA. This will allow you to maximize tax deferral.
Assuming everyone is an eligible designated beneficiary
Another common mistake is assuming everyone listed as a beneficiary is an eligible designated beneficiary (EDB). EDBs are a category of beneficiaries who are exempt from the 10-year rule. EDBs include a minor child and of the original IRA owner, spouse, a beneficiary at most 10 years younger or older than the account owner, and a chronically ill or disabled beneficiary.
You’re not alone
The SECURE Act resulted in major confusions, especially for IRA beneficiaries. It made it challenging for beneficiaries to navigate their accounts to minimize associated taxes and plan ahead. So, the best way to get the best outcome with an IRA is to work with an experienced financial advisor.
Brian Menickella is the founder and managing partner at Beacon Financial Services, a broad-based financial advisory firm based in Wayne, PA.
This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice.