Listen to this articleAs part of the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, a 10-year rule was introduced which requires certain beneficiaries of IRAs to liquidate the inherited accounts within the 10-year period following the death of the original account owner. From the beginning, there was confusion surrounding how inherited accounts needed to be handled during the 10-year period. It was unclear if a distribution needed to be taken in each of the 10 years, or if the account simply needed to be liquidated before the end of the 10th year. Fortunately, the IRS recently introduced regulations to clarify the rule.
First, it is important to understand when the original account owner passed away, and whether the owner was taking RMDs (required minimum distributions) at the time of his or her death. If the owner passed away prior to 2020, the 10-year rule does not apply. Similarly, if the owner died in 2020 or later, but was not subject to RMDs at the time of death, the 10-year rule does not apply. The 10-year rule only applies in cases where the owner passed away in 2020 or later and was subject to RMDs at the time of death.
If the 10-year rule applies, the beneficiary must take a RMD in years one through nine, and fully empty the account before the end of the 10th year. The beneficiary can choose to take a distribution in excess of the RMD in any year, and the account can be emptied prior to year 10.
However, there are exceptions to the 10-year rule for certain classes of beneficiaries. The groups listed below can elect to take distributions from their inherited accounts beyond the 10-year period, with some being able to “stretch” their accounts, or take RMDs for the remainder of their lifetimes:
- The original account owner’s spouse;
- A person who is disabled (as defined by the IRS);
- A chronically ill person (as defined by the IRS);
- A person who is younger than the original account owner by less than 10 years; and
- The original account owner’s minor child (the 10-year rule commences when the child reaches the age of majority).
Considering the initial confusion in interpreting the 10-year rule, the IRS has decided to delay implementation of the clarifying regulations until 2025. If RMDs were missed between 2020 and 2024, no penalties will be assessed, and there is no requirement to “catch-up” on any missed RMDs. Those subject to the 10-year rule should be prepared to fully comply starting in 2025.
Prior to the 10-year rule, beneficiaries could elect to stretch their inherited IRA accounts without any restrictions. Utilizing the stretch was a way in which accounts could pass from one generation to another while the assets in the accounts enjoyed tax deferred growth. Under the previous rules, it was a common planning strategy for the owner of an IRA to preserve and grow the account by only taking RMDs. If each inheriting party implemented the same strategy, the accounts could grow to considerable value and be available for the support of many generations.
The implementation of the 10-year rule could force IRA owners to abandon the aforementioned traditional strategy. Without the ability to stretch the accounts generation after generation (in most cases), some may decide to focus on spending down their IRAs in an effort to preserve other classes of assets that are more attractive to inherit. For example, consider a child inheriting from a parent a $1 million IRA versus a $1 million stock account. With the inherited IRA (assuming the 10-year rule applies), the child must liquidate the account within 10 years, which, after paying the income tax on the distributions, would leave the child with much less than $1 million in cash. Compare that outcome to the stock account where, after enjoying the step-up in basis on the stock (under IRC § 1014), the child could sell the stock immediately upon inheriting it and walk away with $1 million in cash, tax free.
If you think you might be subject to the 10-year rule, or if you want to discuss your options regarding the management of your account during your lifetime, it is essential to consult with your legal, financial and/or accounting professionals. Doing so will allow you to consider all the facts and circumstances specific to your case to ensure that you know all your options and are compliant with all applicable rules and regulations.
Wayne Carrabus is an associate at Futterman Lanza, LLP, with offices in Smithtown, Bay Shore and Garden City. He concentrates his practice on elder law, Medicaid planning, Medicaid applications, estate planning, estate taxes, probate and estate administrations.
