Important legislation is working its way through Congress. The Setting Every Community Up for Retirement Enhancement Act (“
SECURE Act”) as passed by the House of Representatives on May 23, 2019, and would impact how and when an IRA or retirement account beneficiary would be forced to receive distributions from an inherited account. The biggest change under the SECURE Act would be the replacement of the 5-year distribution rule for inherited IRAs with a 10-year rule. It would also eliminate “stretch IRAs.” If signed into law, the Act would impact plan participants and IRA owners who die after January 1, 2020, with limited exceptions.
Under current
tax law contributions to an IRA and retirement plan are not taxed until distributed after retirement (distribution must begin not later than age 70.5). Until distribution the investments grow tax free and create an incentive for a retiree to withdraw from their IRAs as a last resort to avoid taxation, loss of tax shelter, and potential method to pass an inheritance on to beneficiaries.
Under the
SECURE Act, all IRA and retirement plan distributions would need to be completed within a ten (10) year period beginning in the year following the year the participant or IRA owner died. The ten (10) year period would replace the current five (5) year default period and would apply regardless of whether the plan participant or IRA owner died before or after reaching their required minimum distribution date (RMD). The change would apply to distributions to a non-spouse beneficiary from retirement plans and IRAs (including Roth IRAs) made after the death of the plan participant or IRA owner who dies after December 31, 2019.
Limited exceptions apply for: (i) a new class of individuals called “eligible designated beneficiaries” (surviving spouse, minor child, disabled individual or individual that is not more than 10 years younger than the deceased participant); (ii) collectively bargained plans; (iii) certain governmental plans; and (iv) existing annuity contracts. The minor child exception will cease once the minor child reaches the age of majority. Thereafter, the remainder of the distributions to that individual must be completed within ten (10) years after that date. A “disabled individual” includes an individual unable to engage in any substantial gainful activity due to a medically determinable physical or mental impairment. The determination as to the existence of an eligible designated beneficiary will be made upon the death of the plan participant or IRA owner.
For most inherited IRA beneficiaries, the 10-year rule will provide far more flexibility for timing distributions than the existing 5-year rule. However, those desiring to utilize their retirement account as a wealth transfer vehicle could be adversely impacted.
