The Setting Every Community Up for Retirement Enhancement Act (or “SECURE Act”) was enacted on December 20, 2019. The SECURE Act modified the rules for how retirement accounts, including IRAs, are distributed to beneficiaries after the death of the original owner of the account.
In February of 2022, the Department of the Treasury released proposed regulations to clarify the application of the SECURE Act. The proposed regulations contained some surprises for estate planning practitioners.
Prior to the SECURE Act, the general rule was that if the decedent designated an individual person as the beneficiary of his IRA, then the beneficiary would be able to gradually take distributions out of the IRA account on a schedule based on his or her own life expectancy. The SECURE Act changed this general rule for most beneficiaries (some important exceptions being surviving spouses, disabled persons, and minors). Under the current SECURE Act, the general rule for an inherited IRA is that it must be completely distributed to the beneficiary by the end of the calendar year, which includes the tenth anniversary of the original owner’s death (the “10-year rule”). Practitioners have interpreted this to mean that such a beneficiary is free to take distributions from the IRA according to any schedule he pleases (e.g., all at once or in equal yearly increments) so long as the account is emptied by the end of the tenth year. The recently proposed regulations clarify that if the original account holder of the IRA has died after the time that he was required to begin taking distributions, then his designated beneficiary would still need to take minimum distributions out during each of the ten years, according to either his own life expectancy or the life expectancy of the deceased account holder, whichever is longer.
Many owners of an IRA choose their spouses as the beneficiary. The beneficiary spouse may take distributions from the inherited IRA along a schedule according to his or her own life expectancy (or if longer, and the deceased spouse was already required to take distributions, according to the statistical life expectancy of the deceased spouse.) Many practitioners have interpreted SECURE to mean that upon the death of the beneficiary's surviving spouse, the beneficiary designated by the surviving spouse would have a whole ten years in which to take out the rest of the account. However, proposed regulations clarify that upon the death of the surviving spouse, his or her designated beneficiary would only have until the earlier of the end of the surviving spouse’s life expectancy, the end of the original owner’s statistical life expectancy (if distributions had begun before the original owner’s death) or ten years after the death of the surviving spouse.
An IRA owner may name a trust as the beneficiary of his IRA. If the trust meets certain requirements regarding the identifiability of its beneficiaries, then the underlying beneficiaries of the trust may be treated as the designated beneficiaries of the IRA. The criteria for which beneficiaries of a trust are counted as designated beneficiaries of the IRA is significant because the rules require that, in the instance of multiple designated beneficiaries, the life expectancy used for calculating the schedule of distributions (though still subject to the “10-year rule” in most instances) is that of the oldest designated beneficiary. The general rule is that for a trust that does not require distributions from the IRA to immediately be distributed out of the trust, even residual beneficiaries of the trust (who do not currently receive anything from the trust) must be considered designated beneficiaries of the IRA.
The proposed regulations would narrow the field of trust beneficiaries who would be considered designated beneficiaries of an IRA by deeming certain types of beneficiaries to be disregarded. First, the proposed rules allow that a beneficiary of a trust whose interest in the IRA is contingent upon the death of another beneficiary, whose own interest is itself residuary, can be disregarded as a designated beneficiary: roughly, second-tier remainder beneficiaries do not count. Second, if the current trust beneficiary is likely to exhaust the IRA during his lifetime, even first-tier remainder beneficiaries can be disregarded. In particular, if the terms of the trust require that the entire IRA be distributed to a current beneficiary by the later of (1) calendar year following the calendar year of the original IRA owner’s death or (2) the end of calendar year in which said current beneficiary reaches age 31, then the contingent beneficiaries who would take in the event that the current beneficiary died before receiving a full distribution of the IRA are not counted a designated beneficiary for purposes of determining minimum distribution that must be taken each year.
In a nutshell, time is of the essence to review your IRA distribution plan as compliance is more difficult than before, and we must confirm that your financial advisor(s) have your correct and up-to-date beneficiary designations. Please raise this issue at our next annual check-up or sooner.