Inherited Retirement Plan Update

The evolving rules on inherited individual retirement plans over the last two years have been, at best, a little confusing. Initially, the Setting Every Community Up for Retirement Enhancement Act of 2019 (“SECURE Act”), which was generally effective on January 1, 2020, eliminated the stretch IRA and introduced the ten-year rule provisions for plans that include 401(k), 403(b), 457(b), traditional IRAs and Roth IRAs. This rule does not apply to defined benefit plans.

A key date to keep in mind is the retirement account participant’s required beginning date (“RBD”). For IRA holders, this is normally April 1 of the year following the year the holder turns 72. While company retirement plan holders follow a similar rule, most employees can delay this date if they continue to work. A 5% or greater owner of a company with an employer-maintained plan must begin receiving distributions by April 1 of the first year after the calendar year in which they reach age 72, even if they continue to work.

Under the SECURE Act, two types of retirement plan individual beneficiaries were identified:

1. Non-Eligible Designated Beneficiary (“NEDB”)
2. Eligible Designated Beneficiary (“EDB”)

NEDBs are those persons who do not qualify as EDBs. Initially, most believed that the SECURE Act was interpreted as imposing a ten-year payout rule for an individual beneficiary who is not an EDB and who inherits after 2019. That rule requires that an NEDB empty the retirement account by the end of the tenth year following the year the account owner died, with no required minimum distribution (“RMD”) payments during years one through nine. On February 23, 2022, the IRS issued proposed regulations stating that if the participant died on or after their required beginning date, an NEDB would be subject to the ten-year rule and would be required to take annual RMDs (based on the beneficiary’s single life expectancy) during years one through nine of the ten-year period, with the remaining amount emptied out in the tenth year. That interpretation surprised most commentators who thought the ten-year rule would apply similarly to the pre-SECURE Act five-year rule, which did not require annual RMDs. For the SECURE Act, if the participant dies before the RBD, there is no annual RMD during the ten-year period. Roth IRA beneficiaries would be subject to the ten-year rule and would not be required to take RMDs during the ten-year period, since Roth IRA holders are always considered to have died before their RBD.

With respect to EDBs, the beneficiaries are exempted from the ten-year rule. However, if the participant dies before the RBD, the EDB can elect the ten-year rule. EDBs come in five classes:

1. Surviving spouses
2. Minor children of participant, until age 21. Does not include grandchildren
3. Disabled individuals as defined by the IRS
4. Individuals with chronic illnesses
5. Individuals no more than ten years younger than the participant

If the beneficiary is an EDB, distributions are paid over the EDB’s life expectancy.

Once the EDB no longer qualifies as an EDB or dies, the ten-year rule is applied to the individual or their beneficiaries.