On Dec. 20, 2019, the Secure Act Setting Every Community Up for Retirement Enhancement Act – otherwise known as the
As is often the case with statutory language, the SECURE Act included a number of provisions that were either ill-defined or left open to substantial IRS interpretation. Thus, for more than two years, practitioners have been anxiously awaiting the issuance of Treasury regulations to help fill in the gap and answer open questions.
To that end,
For many individuals, the most significant change made by the SECURE Act was the
After the enactment of the SECURE Act, the general consensus among practitioners was that the 10-Year Rule would be implemented in such a manner that would simply require the inherited account to be fully distributed by the end of the 10th year after death. During those 10 years, however, it was thought that beneficiaries would have ultimate flexibility, and the ability to take out as much, or as little, as desired in each of the first nine years after the owner’s death (as long as anything still left in the 10th year after death was distributed by the end of that year).
Then, in early 2021, the IRS issued its annual update to Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs), which included an example that seemed to indicate that Non-Eligible Designated Beneficiaries would be required to abide by regular “stretch” RMDs in addition to the 10-Year Rule. Practitioners immediately raised questions about the publication, and within weeks, an IRS spokesperson indicated that the initial version contained a mistake and that a corrected version of the publication would soon be made available.
To that end, on May 25, 2021, the IRS posted a revised version of
More specifically, the revised Publication of 590-B stated: “The 10-year rule requires the IRA beneficiaries who are not taking life expectancy payments to withdraw the entire balance of the IRA by Dec. 31 of the year containing the 10th anniversary of the owner’s death. For example, if the owner died in 2020, the beneficiary would have to fully distribute the plan by Dec. 31, 2030. The beneficiary is allowed, but not required, to take distributions prior to that date. (Emphasis added.)
In what can only be considered an incredibly surprising turn of events, the new proposed regulations seek to implement a remarkably complex system whereby Non-Eligible Designated Beneficiaries would be split into two distinct groups, each with their own set of post-death distribution rules.
One group would be comprised of Non-Eligible Designated Beneficiaries who inherited from retirement account owners and who died prior to their required beginning date. This group of beneficiaries would be subject to only the 10-Year Rule.
Non-Eligible Designated Beneficiaries who inherited from retirement account owners who died on or after their required beginning date would comprise the second group. And this group of beneficiaries would be subject to both the 10-Year Rule and regular stretch distributions.
In other words, beneficiaries who inherit retirement accounts whose owners die on or after the required beginning date would continue to have to comply not only with the stretch distribution rules in place before the SECURE Act was passed. But on top of those annual minimum requirements in each of the first nine years after death, they would also be required to empty the account by the end of the 10th year after death.
Example 1: Bart is the healthy adult child of Homer and Marge, and will turn 39 years old in 2022. In June 2022, tragedy strikes, and Homer, age 68, and Marge, age 75, are killed in a car accident, leaving Bart as the beneficiary of each of their IRA accounts.
Since Bart does not meet any of the requirements to be an Eligible Designated Beneficiary (discussed in greater depth in the following section), Bart will be a Non-Eligible Designated Beneficiary, and subject to the 10-Year Rule. Notably, though, under the proposed regulations, Bart would be subject to two different sets of post-death distribution rules.
Since Homer died prior to his required beginning date, with respect to the IRA Bart inherits from Homer, he must simply empty the inherited account by the end of 2032 (the 10th year after Homer’s death). Distributions before that time would be allowed, but not required.
By contrast, Marge had already passed her required beginning date (April 1 of the following the year that she turned 72). Accordingly, with respect to the IRA Bart inherits from Marge, he will be subject to both the 10-Year Rule and annual stretch RMDs. Thus, beginning in 2023 (the year after death), Bart would need to begin taking stretch distributions, calculated in the same manner as if the SECURE Act had not been enacted. On top of that, he must be sure to empty the entire inherited IRA from Marge by Dec. 31, 2032.
In the preamble to the
Such an interpretation of the statute seems reasonable, but also unnecessary. In the past, the IRS has certainly interpreted more narrowly written statutes in a much broader manner. To that end, given the complexity such a bifurcated approach to implementing the 10-Year Rule would create, it’s likely that the IRS will receive a substantial number of comment letters recommending a simpler implementation.
It remains to be seen whether any such commentary will sway the IRS’s opinion on the matter, and as such, advisors should begin to consider the implications of such requirements on clients’ plans.
While the
- Surviving spouses
- Individuals who are disabled
- Persons who are chronically ill
- Persons not more than 10 years younger than the deceased individual
- Minor children of the decedent
Notably, although the SECURE Act did provide some definitions to clarify the requirements for qualifying for one or more of the above categories of Eligible Designated Beneficiaries, there remained a substantial number of questions. The proposed regulations provide additional information meant to help close that gap.
Minor children of decedents
Perhaps the group of Eligible Designated Beneficiaries for which practitioners were most anxious for additional clarification was minor children of the deceased retirement owner. Critically, while the definition of who is and who is not a minor is generally a matter of state law, the text of the SECURE Act pointed to
That Section of the Internal Revenue Code, however, redirects taxpayers to
The proposed regulations would modify the existing regulations to provide that, in general, children of a decedent would be treated as reaching the age of majority on their 21st birthday. This would apply to children in all states, regardless of when such an individual would normally reach the age of majority under state law for other purposes. Accordingly, under the proposed regulations, minor children would be subject to the stretch RMD rules beginning in the year after the death of their parent, and continuing through the year of their 21st birthday, at which time, the 10-Year Rule would begin to apply.
Owing to the ages when individuals generally tend to have children, it’s likely that most minor children (i.e., younger than age 21) would inherit from parents dying prior to their required beginning date. Thus, in most situations, minors would not be subject to annual RMDs during the period of time in which the 10-Year Rule applies.
Of course, there will be the occasional situation where a minor child inherited from a retirement account owner who had already reached their required beginning date. In such a situation, under the proposed regulation, that child would continue to be subject to annual RMD requirements both prior to, and during, the application of the 10-Year Rule.
Example 2: Bud is a 5-year-old healthy child of Peggy, age 45, and Al, age 75. In May 2022, Peggy and Al are both killed in a boating accident, leaving Bud as the beneficiary of each of their IRA accounts.
As a minor child of both decedents, Bud would be considered an Eligible Designated Beneficiary under the SECURE Act. And, as provided by the proposed regulations, that status would continue to apply until Bud turned 21, at which point, he would no longer be considered a minor and therefore, from that point forward, would be considered a Non-Eligible Designated Beneficiary subject to the 10-Year Rule.
From age 6 (the year after his parents’ death) through age 21 (the year in which Bud would reach the age of majority under the proposed regulations), the post-death distributions rules to which Bud was subject would be the same for both the IRA inherited from Peggy and from Al. More specifically, Bud would have to take RMDs from each account annually (the same as before the SECURE Act).
Once Bud reached the age of majority, however, he would be subject to two different sets of rules. Since Peggy died prior to her required beginning date, as explained earlier, Bud would not be subject to any RMDs from the account he inherited from Peggy during the period of time in which the 10-Year Rule applied. The annual distribution requirement, which existed from his age 6 through age 21, would stop and he would have to empty whatever was still left in the account by the end of the year in which he turned 31.
The 10-Year Rule would apply to the account inherited from Al in the same manner as it applies to the account inherited from Peggy. Accordingly, that account would also have to be fully distributed by the end of the year in which Bud turned 31. However, since Al died after reaching his required beginning date, Bud would still be subject to annual RMDs from the account inherited from Al each and every year.
It's worth noting that the proposed regulations provide a limited number of exceptions to the “minor children reach the age of majority at 21” rule. One exception, for instance, would allow plans adopted prior to the publication of the final regulations to continue to incorporate their own plan-specific definition of “majority” that is different from that in the final regulations.
In addition, governmental plans, which require only a “reasonable, good faith standard in complying with the rules of section 401(a)(9),” would be allowed to continue to use the age of majority definition incorporated into the existing Regulations, regardless of when those plans were adopted.
Individuals who are disabled
As noted earlier, the SECURE Act included individuals who are disabled in the group of beneficiaries who qualify as Eligible Designated Beneficiaries. It further provided that “disability” would be defined by
The proposed regulations offer several important clarifications regarding the status of such persons.
First, the proposed regulations provide a safe harbor for determining whether an individual is disabled enough to qualify as an Eligible Designated Beneficiary. More specifically, the regulations provide that if an individual has been
Second, the proposed regulations also help to shed light on how the IRS will treat young beneficiaries who may be disabled. Notably, the regular definition of disabled involved a determination of whether the beneficiary is able to engage in substantially gainful activity. But most individuals under 18 don’t engage in substantially gainful activity, regardless of whether or not they are disabled.
Accordingly, the proposed regulations clarify that someone who is under 18 (on the date of the decedent’s death) has a disability if that individual:
…has a medically determinable 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. [emphases added]
Finally, the proposed regulations would require that, in order for an individual to be an Eligible Designated Beneficiary by virtue of having a disability, they would need to provide “documentation” to the plan administrator (or IRA custodian) by Oct. 31 of the year following the year of death.
The proposed regulations do not specify the nature of this documentation though (e.g., is it just a doctor’s note stating that the person is unable to engage in substantially gainful activity for an indefinite period of time?), nor do they outline what, if any, requirements an administrator or custodian would need to meet in verifying such information.
Persons suffering from chronic illness
Persons suffering from a chronic illness are also considered Eligible Designated Beneficiaries under the SECURE Act. In general,
The SECURE Act slightly modifies that definition, removing the 90-day threshold, and replacing it with a requirement that the illness be “reasonably expected to be lengthy in nature,” and thus longer than the regular 90-day requirement.
The proposed regulations reinforce this modified definition, and further provide that, in order to be considered chronically ill for purposes of determining beneficiary status, a chronically ill individual must provide written documentation to the plan administrator (or IRA custodian) by Oct. 31 of the year after the decedent’s death.
Notably, though, unlike the documentation requirement for disabled persons, the proposed regulations specify the nature of such documentation. Specifically, they require that the documentation “include a certification from a licensed health care practitioner” verifying the inability of the individual to complete the two (or more) activities of daily living for at least a “lengthy” period of time.
Persons not more that 10 years younger than the deceased
One of the questions that was raised shortly after the enactment of the SECURE Act was how the IRS would interpret the “10 years younger” portion of the statute. More specifically, there was a question as to whether the IRS would use the actual age of the decedent and the beneficiary, or whether they would use a simpler, more-than-10-calendar-years definition.
For instance, if a deceased IRA owner was born on March 1, 1970, and the IRA account beneficiary was born on Dec. 1, 1980, would the beneficiary be considered “not more than 10 years younger,” since, by calendar years, they are 10 years apart? Or would they be considered more than 10 years younger, since, by actual birth dates, they are 10 years and 9 months apart?
The proposed regulations clarify this point by providing that the actual age of the decedent and the beneficiary must be used in determining whether an individual is an Eligible Designated Beneficiary.
Example 3: AJ is an IRA owner whose date of birth is July 1, 1970. The beneficiaries of his IRA are his two cousins, Bobby and Tommy, whose dates of birth are March 1, 1980, and Aug. 1, 1980, respectively. Unfortunately, in October 2022, AJ dies.
In determining whether Bobby and/or Tommy are Eligible Designated Beneficiaries, we must compare their actual dates of birth to that of AJ. Accordingly, Bobby, who is only 9 years and 8 months younger than AJ will be considered an Eligible Designated Beneficiary and will be able to stretch distributions over his remaining (single) life expectancy.
By contrast, Tommy is 10 years and 1 month younger than 111. Accordingly, he would be considered a Non-Eligible Designated Beneficiary, and would be required to distribute the balance of his portion of the inherited IRA by the end of 2032 (the 10th year after AJ’s death).
The IRS’s decision to interpret the not-more-than-10-years-younger rule based on actual dates of birth is particularly interesting when juxtaposed against the rules for determining whether a retirement account owner can use the Joint life and Last Survivor Expectancy table (the “Joint Table”) to calculate the amount of their RMD. Notably, that table can only be used by those who have dates of birth in calendar years that are at least 11 (more than 10) years apart.
In addition to changes to the post-death distribution rules for many beneficiaries, the SECURE Act also changed the year in which RMDs must begin for retirement account owners. Prior to the SECURE Act, RMDs were generally applicable beginning in the year when an individual reached age 70 1/2.
Notably, prior to the SECURE Act, a surviving spouse who remained the beneficiary of their deceased spouse’s retirement account (i.e., established and maintained an inherited IRA) was not required to begin taking RMDs from the inherited retirement account until the year that the deceased spouse would have turned 70 ½. Similarly, in the event that the surviving spouse died before that time (the year in which the deceased spouse would have turned 70 ½), the surviving spouse’s beneficiaries were treated as though they had inherited directly from the original account owner.
The primary question was how the SECURE Act’s changes should impact surviving spouse beneficiaries who inherited prior to the effective date of the SECURE Act’s changes, but from decedents who would have turned 70 ½ on or after Jan. 1, 2020. In other words, should the SECURE Act’s language be interpreted to mean that a retirement account owner had to actually turn 70 ½ on or after Jan. 1, 2020 (meaning they would have needed to live until at least that date), or merely that the individual would have turned 70 ½ on or after January 1, 2020, had they lived?
Thankfully, for ease of administration, the IRS appears on track to take the latter viewpoint. Because if a decedent was born on or after July 1, 1949 (and thus, would have turned 70 ½ on or after Jan. 1, 2020, had they lived), surviving spouses remaining as a beneficiary of such individuals accounts will not be required to take RMDs until the year the decedent would have turned 72.
Similarly, in the event that the surviving spouse beneficiary dies before the year in which the original decedent would have turned 72, the surviving spouse’s beneficiaries will be treated as inheriting directly from the original retirement account owner.
Under the old rules, Designated Beneficiaries of decedents who died prior to reaching their Required Beginning Date were able to opt out of the stretch and into the 5-year rule that applies to Non-Designated Beneficiaries inheriting from the same individuals. Accordingly, a natural question on the minds of many planners after the SECURE Act was enacted was whether Eligible Designated Beneficiaries who inherit from the same individuals (someone dying prior to reaching their Required Beginning Date) would be able to opt out of stretch distribution in favor of the 10-Year Rule that the SECURE Act applies to Non-Eligible Designated Beneficiaries.
New Proposed Treasury Regulation 1.401(a)(9)-3(c)(5)(C)(iii) makes it clear that the IRS intends Eligible Designated Beneficiaries to make just such an election. Specifically, the Proposed Regulations state:
A defined contribution plan may include a provision, applicable to an employee who dies before the employee’s required beginning date and who has an eligible designated beneficiary, that permits the employee (or eligible designated beneficiary) to elect whether the 10-year rule in paragraph (c)(3) of this section or the life expectancy rule in paragraph (c)(4) of this section applies.
It’s worth noting that while the proposed regulations permit a plan or IRA custodian to allow such an election, they don’t require that such an option be granted. In fact, the proposed regulations go so far as to explicitly state that a plan need not make both options available at all. Rather, the plan/IRA can simply require Eligible Designated Beneficiaries to use the 10-Year Rule or the stretch!
The rules for retirement accounts are complicated. The rules for trusts are complicated. Put them together and you get… well… something really complicated!
Unfortunately, the recently released proposed regulations don’t do a whole lot to reduce the complexity introduced to a plan by naming a trust as the beneficiary of a retirement account. They do, however, seek to provide material clarifications on a variety of matters that have perplexed planners for years.
Critically, the proposed regulations contemplate leaving in place much of the existing
Under the existing regulations, remainder beneficiaries of a Conduit Trust are disregarded when determining the post-death payout schedule applicable to a see-through trust that has been named as the beneficiary of a retirement account, and the proposed regulations would continue to allow such treatment. But the proposed regulations also introduce several new types of trust beneficiaries that can be disregarded.
One new group of trust beneficiaries that could be disregarded is secondary beneficiaries of Discretionary (Accumulation) Trusts who are only able to inherit trust assets because of the death of another secondary beneficiary.
In order for this exception to apply, the first secondary beneficiary must survive (and be treated as surviving) the retirement account owner.
Example 4: John Doe has created the John Doe Retirement Account Trust to provide for the management of his retirement accounts after his death. The trust is a Discretionary Trust, and names his spouse, Jane Doe, as the first-in-line beneficiary of the trust.
In the event that Jane Doe dies prior to the distribution (from the trust) of all retirement assets left to the trust, John’s brother, Jim Doe, is next-in-line to receive such distributions. And should Jim die prior to the distribution (from the trust) of all retirement assets left to the trust, John’s favorite charity is entitled to any remaining amounts.
Here, provided that Jane (a primary beneficiary of the trust) and Jim (a secondary beneficiary of the same trust) both survive John, the charity would be a secondary beneficiary of the trust that would only be able to receive assets after the death of Jim, another secondary beneficiary (who had survived the decedent). Accordingly, the charity would be disregarded when determining the post-death distribution schedule.
Another new group of trust beneficiaries that could be disregarded under the Proposed Regulations is trust beneficiaries of Discretionary Trusts who can only receive distributions of retirement assets left to the trusts that first require the full distribution of assets to a minor trust beneficiary by no later than the end of the year in which they reach age 31.
That, needless to say, is an absolute mouthful, and is best explained via an example. So, let’s look at one…
Example 5: Ned is a single IRA owner who has a 15-year-old daughter, Sansa. Accordingly, Ned establishes a Discretionary Trust for his daughter.
The trust provides that, while the trustee shall have discretion over how much of the IRA should be paid to Ned’s daughter annually until she is 30, whatever is left in the trust in the year that Sansa turns 31 must be distributed to her before the end of the year.
In the unlikely event that Ned’s daughter does not receive all of the retirement assets left to the trust — which, by the trust’s terms, necessarily means that she has died before the end of the year in which she turned 31 — the trust assets are to go to Ned’s mother, who is 85.
Since the only way Ned’s mother is entitled to any of the retirement assets left to the trust is if Sansa dies, and since the trust must pay out all of the retirement assets to Sansa no later than the end of the calendar year in which Sansa turns 31, Ned’s mother can be disregarded for purposes of determining the post-death distribution schedule applicable to the trust.
Another significant trust-related element of the proposed regulations would prevent the inclusion of a general power of appointment from causing the trust to fail to meet the
More specifically, to the extent that an individual is granted a power of appointment over trust assets, provided that such power is exercised by Sept. 30 of the year following the year of death in favor of one or more beneficiaries who are all identifiable (or restricts their unexercised power to a limited group of identifiable beneficiaries), the identifiable beneficiaries (or limited group of potential future beneficiaries) will be considered a beneficiary of the trust.
If, on the other hand, such a power of appointment has neither been exercised, nor restricted, by Sept. 30 of the year following the year of death, the proposed regulations would treat the power-holder as a trust beneficiary.
Finally, to the extent that a power of appointment was exercised after Sept. 30 of the year after death, any such appointed beneficiaries would, from that point forward, be treated as a beneficiary of the trust, along with the power holder.
Example 6: Ty died on Jan. 15, 2022, and left his IRA to his trust. Under the terms of the trust, his daughter, Cersei, has a general power of appointment and can decide to whom the IRA shall pass (via the trust). Cersei is considering appointing her son, Joffrey, who is 25 years old and disabled, as the beneficiary of the trust (assume the trust has standby special needs trust language to avoid assets from being available to Medicaid, etc.).
If Cersei exercises her power of appointment in favor of Joffrey by Sept. 30, 2023 (the year after Ty’s death), then only Joffrey will be considered a beneficiary of the trust. Furthermore, since Joffrey is disabled, the trust would be able to stretch distributions over Joffrey’s 60-year life expectancy.
If, on the other hand, Cersei did not exercise her power by September 30, 2032, then she would be considered a beneficiary of the trust, and thus, would force the trust to be subject to the 10-Year Rule (even if she later exercised her power in favor of Joffrey).
If finalized by the IRS, this element of the proposed regulations would mark a dramatic shift from the IRS’s historical viewpoint by relaxing its stance with respect to post-death powers of appointment. Notably, in the past, to the extent an applicable trust beneficiary held a general power of appointment on the date of death, the IRS viewed the trust as failing to meet the See-Through Trust requirement that trust beneficiaries be identifiable. Accordingly, such trusts were considered Non-Designated Beneficiaries, and subject to the less favorable post-death distribution rules that apply to such beneficiaries.
In another departure from IRS historical norms, the proposed regulations contemplate allowing trust beneficiaries to be added and removed pursuant to timely state-authorized trust modifications.
More specifically, in the event that a trust is modified via a method provided for under state law (e.g., court reformation, decanting to a new trust) any trust beneficiaries removed via such a process by Sept. 30 of the year following the year of death will not be considered when determining the trust’s post-death payout schedule. On the flip side, beneficiaries added via such a process will be considered beneficiaries of the trust when determining the applicable post-death distribution rules.
In the past, the IRS has repeatedly ruled that the trust language as of the date of death was instructive of the applicable trust beneficiaries. If finalized, this provision would allow trusts with drafting errors, unwanted beneficiaries, etc., a limited window of time in which they could be “corrected: after death using methods authorized under state law.
The much-anticipated proposed regulations provide valuable insight into how the IRS is thinking about updating its rules to accommodate the changes made by the SECURE Act. Indeed, much of the proposed regulations are likely to remain the same when all is said and done.
There are, however, some very obvious elements (e.g., the application of the 10-Year Rule) of the proposed regulations that neither align with conventional wisdom nor are particularly taxpayer-friendly. Accordingly, it’s likely that the IRS will receive a substantial number of comments about such matters, potentially leading it to revise its position when the final regulations are ultimately published.
But while nothing can be certain at this point, it appears that the IRS is prepared to make some major concessions in a number of areas that would be to the benefit of many taxpayers. Its proposed treatment of surviving spouse beneficiaries would greatly simplify administration, and its proposed revisions to the trust-as-retirement-account-beneficiary rules would be a material improvement over the existing regulations in a variety of ways.
Given the timing of the proposed regulations and comment period, and the fact that the proposed regulations themselves contemplate applicability for 2022, it’s likely that we’ll have a final version of the regulations before the end of the year.
Until then, advisors should keep an eye out for when the rules are finalized, prepare certain Non-Eligible Designated Beneficiaries for the potential of unanticipated distributions that could be required by year-end, and note trusts that may need to be reviewed in light of changes to the regulations.
