The SECURE Act passed in 2019 significantly changed how retirement accounts are inherited. The SECURE Act stands for Setting Every Community Up for Retirement Enhancement. Before the SECURE Act, when an individual inherited a retirement account, he or she was able to maximize the income tax effect by stretching out the withdrawals over his or her life expectancy through required minimum distributions (RMDs). RMDs were calculated based on the inheritor’s actuarial life expectancy.

Key SECURE Act Provisions

  • Penalty-free withdrawal of up to $5,000 for each parent for the birth or adoption of a child
  • The Kiddie Tax reverts to unearned income of a child being taxed at the marginal tax rates of the child’s parent(s), as opposed to tax rates of trusts and estates
  • Contributions are permitted past age 70.5 as long as the individual receives earned wages
  • Required beginning withdrawal period increased to age 72 from 70.5
  • Waiver of 10% penalty for disaster distributions up to $100,000

The biggest impact of the SECURE Act is that many beneficiaries are no longer able to stretch inherited retirement account benefits over their lifetimes. Under the old law, designated beneficiaries were able to take annual distributions throughout their lifetimes based on life expectancy. On the other hand, if retirement account benefits were left to non-designated beneficiaries, the beneficiaries would have to liquidate the plan within five years of the plan participant’s death if he or she died before the RMD start period or within the plan participant’s remaining life expectancy if the plan participant died after the RMD distribution date.

The SECURE Act provides for three categories of beneficiaries: Designated Beneficiaries; Non-Designated Beneficiaries and Eligible Designated Beneficiaries.

Designated Beneficiaries

A designated beneficiary is any beneficiary that is not an entity or that does not fall within the eligible designated beneficiary category. A trust that qualifies as a “see-through” trust is considered a designated beneficiary. To qualify as a see-through trust the trust must not have non-individual beneficiaries except for other qualified see-through trusts. An example of a non-individual entity is a charity.

Under the SECURE Act, designated beneficiaries must liquidate the account within ten years of the plan participant’s death. There are no required minimum distributions and no restrictions on how the money is withdrawn – only that the entire account is fully withdrawn within ten years. If you are the beneficiary of a retirement account, this can be an opportunity for income tax planning. For example, if you know you are going to have a significant increase of income in one year, you can defer distributions to the following year. Conversely, if you experience a significant decrease of income, then it might make sense to take a withdrawal or larger withdrawal within the year.

Non-Designated Beneficiaries

A non-designated beneficiary is any beneficiary that does not have a life expectancy, such as certain non-qualified trusts, estates, and charities. Non-designated beneficiary treatment remains mainly unchanged, in that a non-designated beneficiary must liquidate the retirement plan subject to the five-year rule or plan participant’s life expectancy.

Eligible Designated Beneficiaries

The SECURE Act established this new class of beneficiaries who can inherit a retirement account based on their life expectancy. Beneficiaries in this class consist of surviving spouses, minor children of the plan participant, disabled beneficiaries, chronically ill beneficiaries, and beneficiaries less than ten years younger than the plan participant.

Surviving Spouse – a surviving spouse is entitled to a life expectancy payout and RMDs annually based on the surviving spouse’s life expectancy.

Minor Child – a minor child of a plan participant is entitled to a life expectancy payout until he or she reaches the age of majority, at which time the ten-year designated beneficiary withdrawal rule applies. This class only consists of minor children of the deceased plan participant; minor grandchildren of a plan participant are not considered eligible designated beneficiaries and are subject to the ten-year payout rule. The age of majority is determined by state law, usually either age 18 or 21. For example, if a state’s age of majority is age 18, then once a child reaches the age of 18 the account must be fully withdrawn by age 28.  However, a provision included in Treasury Regulation Section 1.401(a)(9)-6 Q&A 15 states that a child may not be treated as having reached the age of majority if he or she has not yet completed a specified course of education and is under age 26.

Chronically Ill – Requiring assistance with two activities of daily living indefinitely that is expected to be lengthy in nature qualifies an individual as chronically ill for purposes of eligible designated beneficiary status.

Disabled – Receiving social security disability benefits should qualify a disabled individual for eligible designated beneficiary status.

Beneficiary Less than Ten Years Younger – a beneficiary who is less than ten years younger than the deceased plan participant is entitled to a life expectancy payout. A beneficiary can be older than a deceased plan participant but cannot be more than ten years younger. For example, if a 57-year-old plan participant dies and a 65-year-old beneficiary inherits the retirement account, then the beneficiary can use his or her life expectancy to withdraw the funds. 

The SECURE Act is one of the most significant pieces of retirement plan legislation in years, with the most important piece of the legislation being the changes to distribution rules for beneficiaries of retirement accounts. If you have retirement accounts, or if you are a beneficiary of a retirement account, and you would like to further discuss these important changes to the law, call Alex Carr Law, LLC today.