The SECURE Act eliminated the stretch IRA for most non-spouse beneficiaries. It was replaced with a 10-year payout rule that requires these beneficiaries to empty the entire inherited individual retirement account balance by the end of the 10th year after death. The new rules apply to beneficiaries who inherit in 2020 or later years.
Beneficiaries who inherited any time before 2020 will follow the old rules, from prior to the SECURE Act, under which they still may qualify for a stretch IRA. In addition, spouses are largely unaffected by the SECURE Act since they are “eligible designated beneficiaries," meaning that they are exempt from the elimination of the stretch IRA.
It’s important for advisers to recognize into which category the beneficiary falls and which set of post-death payout rules apply.
Under the SECURE Act, there are three categories of beneficiaries:
• Non-designated beneficiaries, or NDBs (no named beneficiary): No stretch IRA, these rules are the same as prior to the SECURE Act.
• Non-eligible designated beneficiaries, or NEDBs: No stretch IRA; the 10-year rule applies.
• Eligible designated beneficiaries, or EDBs: Stretch IRA still applies.
1. Pre-2020 beneficiaries are getting bad info -- the stretch IRA is still alive for them. If a non-spouse designated beneficiary (meaning the beneficiary was named on the IRA beneficiary form) inherited in 2019 or earlier, that beneficiary qualifies for the stretch IRA for the rest of the beneficiary’s lifetime. This payout schedule is not affected by the 10-year rule under the SECURE Act. Some of these beneficiaries have already been told that the SECURE Act rules have shortened their payout term to the new 10-year period. Not true.
Example: Mary (a designated beneficiary) inherited her mother’s IRA back in 2015 when she was 39 years old. At that point, Mary was able to stretch her payouts over 43.6 years. She can continue that schedule unless she chooses to empty the inherited IRA account before then. The SECURE Act does not affect this continuing stretch IRA. However, when Mary dies, if there is a balance left to a successor beneficiary, that beneficiary will be subject to the 10-year rule. Under the old rules, that successor beneficiary could have continued the remaining payout term after Mary’s death, but not anymore. If Mary had inherited in 2020 or a later year she would be an NEDB and subject to the 10-year rule (no stretch IRA).
2. Spouses can still do spousal rollovers, or stretch. The 10-year rule does not prevent a spouse from doing a spousal rollover or electing the stretch if he or she decides to keep the account as an inherited IRA.
Example: Jill, age 55, inherited an IRA from her husband John, age 68, in 2020. She can do a spousal rollover and begin taking required minimum distributions at age 72. In this case, the 10-year rule will not apply. However, because a spouse is an EDB, Jill could also elect to keep the account as an inherited IRA and use the stretch. RMDs would need to start when John would have reached age 72. By choosing this option, Jill can avoid the 10% early distribution penalty because distributions from inherited IRAs are always penalty-free. The 10-year rule would not eliminate this option for a spouse beneficiary.
While the 10-year rule is not required for a surviving spouse, when that spouse dies, their beneficiary will generally be subject to it, unless after a spousal rollover the spouse remarries and leaves the IRA to his or her spouse, or to some other EDB, like a minor child, disabled or chronically ill beneficiary or a beneficiary who is not more than 10 years younger than him or her.
3. Non-designated beneficiaries, or NDBs, are unaffected by the SECURE Act. If no beneficiary is named on the beneficiary form or the IRA beneficiary is the estate, a nonqualifying trust or a charity, the pre-2020 rules still apply, regardless of when death occurs. There is no 10-year rule. If there is no designated beneficiary, the NDB will follow the same rules as before, which depend on whether the retirement funds were inherited before or after the required beginning date for RMDs (age 70½, or age 72 for those who turned 70½ in 2020 or later).
Those rules state that if the death was before the required beginning date, the five-year rule would apply. If the death occurred on or after the required beginning date, the deceased IRA owner’s remaining single life expectancy would apply, as if they lived -- sometimes referred to as “the ghost rule.”
Make sure beneficiaries are receiving the right advice, based on what category they fall under and when they inherited.
[More: No stretch IRA? No problem]
For more information on Ed Slott, Ed Slott’s 2-Day IRA Workshop and Ed Slott’s Elite IRA Advisor Group, please visit www.IRAhelp.com.
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