The SECURE Act: Recent Changes to IRA and Qualified Retirement Account Distribution Rules
The Setting Every Community Up for Retirement Enhancement (SECURE) Act (“Act”) was signed into law on December 20, 2019, and went into effect on January 1, 2020. The Act changes the required minimum distribution (RMD) rules for IRAs and qualified retirement accounts (“Accounts”) and increases the age at which Account owners are required to begin taking RMDs (required beginning date or RBD) from age 70 ½ to age 72. This change applies to individuals who will attain the age of 70 ½ on or after January 1, 2020.
PRE-JANUARY 1, 2020 RULES (“PRIOR RULES”)
Under the Prior Rules, the RMD is determined based on two factors: (1) whether the Account owner died before or after his or her RBD; and (2) the status of the beneficiary.
If the beneficiary qualifies as a “Designated Beneficiary,” the beneficiary can “stretch” distribution of the Account by calculating RMDs based on his or her own life expectancy (“Life Expectancy Rule”). Most individuals qualify as Designated Beneficiaries, while estates and charities do not. By naming a beneficiary in a younger generation, such as a child or grandchild, an Account owner could expect the Account balance to last for several decades.
If a beneficiary does not qualify as a Designated Beneficiary, the beneficiary cannot use the Life Expectancy Rule. If the Account owner died before his or her RBD, a non-Designated Beneficiary must take distribution of the Account balance by the end of the fifth year following the year of the Account owner’s death (“Five-Year Rule”). If the Account owner died on or after his or her RBD, a non-Designated Beneficiary must calculate RMDs based on the Account owner’s remaining life expectancy (“Ghost Rule”).
Certain trusts meeting requirements set forth in the Internal Revenue Code (known as see-through trusts) qualify as Designated Beneficiaries and benefit from the Life Expectancy Rule.
Under the Act, the RMD is determined based on the same two factors as under the Prior Rules: (1) whether the Account owner died before or after his or her RBD; and (2) the status of the beneficiary. The major changes implemented by the Act are the extension of the RBD to the year in which the Account owner reaches the age of 72, and the shortening of the period over which RMDs must be taken by the beneficiary.
Beneficiaries continue to be categorized as Designated Beneficiaries or non-Designated Beneficiaries. Designated Beneficiaries must now take distribution of the remaining balance of the Account by the end of the 10th year following the year of the death of the Account owner (“Ten-Year Rule”). This means that children of the Account owner who are over the age of majority and more remote issue named as beneficiaries of an Account can no longer use the Life Expectancy Rule.
There is an exception to the Ten-Year Rule for Designated Beneficiaries who qualify as “Eligible Designated Beneficiaries,” which is a new category introduced by the Act. Eligible Designated Beneficiaries can use the Life Expectancy Rule when calculating RMDs. Eligible Designated Beneficiaries include (1) the Account owner’s surviving spouse, (2) the Account owner’s minor children1, (3) disabled or chronically ill persons, and (4) individuals less than 10 years younger than the Account owner.
Non-Designated Beneficiaries must use the Five-Year Rule or the Ghost Rule to calculate RMDs depending upon whether the Account owner died before or after his RBD.
The Ten-Year Rule also applies to see-through trusts for the benefit of Designated Beneficiaries who do not qualify as Eligible Designated Beneficiaries. Depending on how a see-through trust is drafted, distribution of the entire Account balance to the trust beneficiary may be required by the end of the 10-year period.
Account owners should review beneficiary designations and estate planning documents to ensure the documents are consistent with the Account owner’s goals, particularly in situations where the Account owner has named or plans to name a see-through trust as beneficiary of the Account.