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THE SECURE ACT, which took effect Jan. 1, 2020, made inheriting an IRA even more complicated. Before 2020, beneficiaries typically had the option of taking distributions from an inherited IRA over their lifetime, potentially squeezing many more years of tax-favored growth from these accounts.
The SECURE Act drew a new line, eliminating some beneficiaries’ ability to make use of the so-called stretch IRA. Beneficiaries now are divided into two groups. Some have to empty an inherited IRA within 10 years of the original owner’s death. Others are permitted to stretch out their withdrawals for longer, often over their estimated lifetimes.
I want to focus on this second group—called eligible designated beneficiaries—who can still defer taxable distributions for longer than 10 years. It includes more people than you might think. Under the SECURE Act, eligible designated beneficiaries include:
Surviving spouses continue to have the most flexibility because they’re allowed either to roll over an inherited IRA into their own IRA account, and potentially delay all withdrawals until age 72, or to leave the money in the inherited IRA. The key advantage: Spouses have the flexibility to either stretch withdrawals over their own life expectancy or over the deceased account holder’s “life expectancy,” as calculated by the IRS, which could be beneficial if that happens to be longer.
Disabled and chronically ill individuals can also stretch withdrawals over either their life expectancy or the remaining life expectancy of the deceased. Unlike a spouse, however, they aren’t allowed to roll over the IRA into their own account. Instead, they must use an inherited IRA account to shelter assets until they’re withdrawn.
Minor children of the IRA owner—but not grandchildren—can stretch their withdrawals, but not for a lifetime. Their 10-year withdrawal clock starts when they reach the age of majority—which differs by state—or as late as age 26 if they’re completing their education.
Beneficiaries who are less than 10 years younger than the IRA owner can still take advantage of lifetime withdrawals. This is where it gets interesting. The “less than 10 years younger” rule happens to include any beneficiary who is older than the account owner. This means older siblings, friends or domestic partners could be entitled to stretch their IRA withdrawals over their own life expectancy.
I’ve found this aspect of the law isn’t yet widely understood. For instance, I just completed a continuing education course on the new rules for IRAs that incorrectly stated that parents and grandparents don’t qualify for lifetime distributions. They all would qualify because, presumably, they’d all be older than the original IRA owner.
Applying the same rule, cohabiting adults who are within 10 years of the deceased’s age also qualify for the stretch rules. The surviving adult would be able to take lifetime withdrawals if listed as the IRA’s sole beneficiary.
The new rules also apply to Roth IRAs, but with one additional condition, which concerns the five-year rule. If the Roth account was established less than five years before the account owner’s passing, the beneficiary must wait to withdraw assets until that requirement is met to ensure the withdrawals are tax-free. This is one more reason to establish Roth IRAs as early as possible.
Who loses out under the SECURE Act? Younger beneficiaries, such as the grandchildren of IRA owners. Before 2020, they might have stretched inherited IRA withdrawals over six or seven decades, allowing the account to enjoy enormous compound growth. Now, their inheritance must be withdrawn from the sheltering arms of an IRA in no more than 10 years. Under the new rules of the game, our grandparents are welcome to take a stretch, but not our more limber grandchildren.
James McGlynn, CFA, RICP, is chief executive of Next Quarter Century LLC in Fort Worth, Texas, a firm focused on helping clients make smarter decisions about long-term-care insurance, Social Security and other retirement planning issues. He was a mutual fund manager for 30 years. James is the author of Retirement Planning Tips for Baby Boomers. Check out his earlier articles.
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Where in the IRS instructions can I find the section to support your statement ‘The “less than 10 years younger” rule happens to include any beneficiary who is older than the account owner’ since it is not widely understood. I am a parent with an inherited Roth IRA from my deceased son.
Debby that’s an excellent question. I have only found it in reading articles analyzing how it should be interpreted. The IRS is still making announcements clarifying the new laws. I believe in June there should be more announcements.
Very well written article, and good information. Thanks.
Thanks Rick. One very weird “trick” is that an eligible designated beneficiary can elect the 10 year payout- if the deceased had not started RMD’s-and then switch to lifetime withdrawals thereby avoiding 10 years + lifetime.
Not avoiding but increasing the delay 10 years + lifetime….
Excellent article. I further recommend a blog by Mr. Jeffery Levine at Kitces on this topic. https://www.kitces.com/blog/secure-act-stretch-ira-401k-elimination-eligible-designated-beneficiary-retirement-accounts-taxes/
I have also seen people subject to the SIMPLE act who are still are working with earned income, but who have not been doing the 401(k) or traditional IRA maximum contributions, to bump up their retirement accounts to the maximum and replace the W-2 cash with the cash distributions from the inherited IRA. Result, typically same taxable income and a longer deferral period. For many, they may be able to drain the inherited IRA over the ten year required period and then have lifetime deferral over their own 401(k)/IRA. For those who can’t empty the inherited IRA in ten years having the remaining balance is not a bad problem to have. Maybe move to a state without an income tax before the 10th year and fund a donor advised charitable account in the tax year of the final distribution.
If you did inherit an IRA or Roth IRA before 2020, and are taking the money out based on your life expectancy, listen up! The new IRS life expectancy tables can benefit you, but it is complicated.
As you know, when you first inherited the IRA or Roth, you looked up your life expectancy in the single life-table, and divided the amount as of Dec 31 of the decedent’s death by that. Every year thereafter, you subtracted 1 year from your life expectancy to calculate the RMD for that year.
Now you should take the new table, and look up you life expectancy for the year you first took a withdrawal. Then subtract the number of years since then to determine this year’s RMD, and use that number from now on until the account is exhausted. You may lower your required RMD by as much as 100 basis points, depending when you inherited and how old you are now.
I got this information from a major financial magazine, but you may want to check the IRS publication when it comes out.
Thank you, Ormode, for this. I would have otherwise puzzled as to why Fidelity’s RMD calculation seemed wrong this year, for my inherited IRA. I just calculated myself based on the new life expectancies — the numbers match Fidelity’s, so I would assume the information is correct. An unexpected gift from the IRS, and a gift from my dad that keeps on giving!