IRAs and 401(k)s, as well as 403(b)s and 457s, are among the preferred ways to save for retirement. In the past, if you inherited part of a family fortune (regardless of size) through tax-advantaged accounts, you could stretch your spending over your expected lifetime. And the younger you were, the longer your assets could grow in that tax-advantaged environment.

But that changed in December 2019. Congress passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act – which took effect on Jan. 1, 2020, and ended that “stretch” strategy for many. Instead, unless you fit a specific beneficiary profile, called an Eligible Designated Beneficiary or EDB, you now had to empty the account within ten years of the account holder’s death date through post-death Required Minimum Distributions (RMDs). This rule became known as the 10-Year Rule.

But some details of how to apply the SECURE Act to RMDs remained unclear.

Are there new RMD regulations?

Earlier this year, the IRS finally released new regulations governing the RMDs from inherited IRAs and 401(k)s (including Thrift Savings Plans or TSPs). These regulations changed some RMD rules dating back to 2002, including those cited in the 2019 SECURE Act, and will affect RMDs paid for 2022 forward.

What are the three groups of beneficiaries?

Suppose you are in any way involved in the inheritance of tax-advantaged accounts. In that case, the first step is to determine to which of the following three types of beneficiaries you belong:

  • Non-Designated Beneficiary (NDB)
  • Non-Eligible Designated Beneficiary (NEDB)
  • Eligible Designated Beneficiary (EDB)

An NDB is an estate, charity or non-qualifying trust (one that is not a “look-through” trust).

An NEDB is a designated beneficiary who does not qualify as an EDB, as described below. These could be grandchildren, older children or some look-through trusts.

EDB status is determined at the account owner’s death date and cannot be changed. An EDB, who can still enjoy the pre-SECURE Act “stretch” rules, includes:

  • A designated beneficiary of an account holder of a traditional IRA or company retirement plan who died before the SECURE Act took effect on Jan. 1, 2020 (including qualifying trusts such as those established for the sole benefit of an EDB),
  • The surviving spouse of the deceased account holder,
  • A minor child (but not a grandchild) of the deceased account holder until their 21st birthday, regardless of the state’s age-of-majority rule or whether or not the child is still in school,
  • A disabled individual, according to IRS Tax Code 72(m)(7),
  • A chronically ill individual, or
  • An individual not more than 10 years younger than the account holder.

The new regulations tightened the definition of “minor child,” which before deferred to the state’s age-of-majority rule and extended up to age 26 if the child was still in school.

The regulations also changed the definition of “disabled.” It now follows Tax Code section 72(m)(7). A disabled adult cannot be able to perform any job because of “any medically determinable physical or mental impairment that can be expected to result in death or to be of long-continued and indefinite duration.”

A disabled child will have a “physical or mental impairment that results in marked and severe functional limitations and that can be expected to result in death or to be of long-continued and indefinite duration.” Someone determined by the Social Security Administration to be disabled is automatically classified as an EDB.

Disabled and chronically ill beneficiaries have until October 31 of the year following the year of the death of the IRA owner or plan participant to provide documentation to the IRA custodian or plan administrator.

What do the post-death payout rules look like today?

Once you determine what kind of beneficiary you are, you’ll want to know how that impacts your inheritance.

For many, the elimination of the stretch IRA rules took effect for deaths after December 31, 2019, at which time the 10-Year Rule became applicable to defined contribution plans (including 401(k), 403(b) and 457(b) plans), plus traditional and Roth IRAs. (Defined benefit plans are not affected.)

However, if your inheritance comes from specific 403(b) and 457(b) plans, Thrift Savings Plans or collectively bargained plans, the recently issued regulations may have extended its effective date by two years, to deaths after Dec. 31, 2021.

Here are the payout rules for the different types of beneficiaries:

For NDBs: Payout rules vary based on whether the account holder dies before or after its Required Beginning Date (or RBD) for required distributions. For most people, the RBD is April 1 after the year of the account holder’s 72nd birthday.

If the account holder dies before the RBD, the 5-Year Rule applies, and the account must be emptied before the end of the fifth year after the death, with no RMDs being required during those five years.

If the account holder dies on or after the RBD, the “Ghost Life” Rule applies. RMDs must be taken according to the deceased account holder’s remaining single life expectancy, which could result in a post-death payout longer than 10 years.

For NEDBs: Are you an NEDB? Again, payout rules are based on whether the account holder dies before or after the RBD. In all cases, the account must be emptied (according to the 10-Year Rule) by the end of the tenth year after death.

If the account holder dies before the RBD, no annual RMDs exist during the 10-year payout window.

If the account holder dies on or after the RBD, annual RMDs must be taken for interim years 1 through 9.

For EDBs: Do you qualify as an EDB? If so, you can enjoy the pre-2020 stretch IRA rules, which allow you to extend the distribution of tax-advantaged accounts over your life expectancy. However, if you lose qualification as an EDB or die, the 10-Year Rule applies to you or to your beneficiaries (that is, for successor beneficiaries).

Application of the pre-2020 stretch IRA rules, the 10-Year Rule and the 5-Year Rule become more complex when there are multiple beneficiaries on a tax-advantaged account, among other situations. The financial implications of such inheritances are significant enough to seek help if you have any doubts about how the new rules apply to you.

Unfortunately, the government does not move quickly nor make these things easy to understand. My apologies for the alphabet soup in this article. I tried to make it easier to “digest.”

This article originally appeared in Old Colony Memorial

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