A little more detailed look into the SECURE Act and what it may mean to you.
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On July 18, 2024, the IRS issued the long awaited final regulations to many provisions of 2019's SECURE Act. Perhaps most anticipated were those regulations relating to the distribution requirement for beneficiaries of individual retirement accounts (IRAs) and 401(k)s. We detail the key takeaways below, with the historical context on the SECURE Act.
The Setting Every Community Up for Retirement Enhancement Act—or SECURE Act—was enacted in 2019. It made numerous changes to retirement and tax-advantaged accounts. However, some of those changes created some confusion among financial and tax professionals. Chief among those was a new 10-year withdrawal rule for retirement accounts inherited by non-spouses (10-Year Rule). This changed the previous rule allowing those who inherited a retirement account to spread out withdrawals over their own lifetime.
Typically, when a law as extensive and as complex as the SECURE Act is passed, a government agency such as the Treasury Department, must interpret and supplement the law with more detailed regulations before the law is fully enforced. For the past four years, advisors have operated in the unknown as far as the rules related to distributions for clients with inherited retirement accounts.
In 2022, the Treasury Department issued proposed regulations. One of the rules that created the most controversy and confusion stated that most beneficiaries subject to the 10-Year Rule would also be required to make required minimum distributions (RMDs) during years one to nine, with the rest of the account’s balance needing to be depleted by the end of year 10. This came as a shock to many financial advisors, wealth managers and tax professionals who felt that the plain text of the legislation would not require RMDs. The IRS considered this feedback and formally waived any potential RMDs for years 2021 through 2024 until final regulations would be issued.
These final regulations are here now and have become legally effective. In those 260 pages of rules, they confirm the position that the IRS took in the proposed regulations: in most circumstances, RMDs are required for non-spousal beneficiaries that have inherited retirement accounts. So, what now?
This series of articles will dive into some more of the intricacies and potential effects of these regulation in the future, but here are some initial takeaways advisors and their clients should be aware of:
1. Who is affected: The 10-Year Rule and continuing RMDs apply to most non-spousal beneficiaries
If a retirement account is inherited by a spouse, these rules do not apply. However, they will apply to children, grandchildren or anyone else who inherits an IRA or 401(k).
2. What retirement accounts are affected: Continuing RMDs apply only if the deceased person was already required to take RMDs from the account
The current time period for starting to withdraw RMDs from retirement accounts is April 1st following the year the owner reaches age 73.
If your client inherited an account from someone who died before reaching that date, your client is not required to start taking RMDs from the account as soon as they have inherited the account. Instead, you can help your client plan their withdrawals to optimize for income tax results. However, the entire account must be withdrawn by the tenth year of the year following the death of the account owner as required by the 10-Year Rule.
3. When are taxpayers affected: Those who inherited an account won’t be penalized for missing withdrawals in 2020-2024, but the 10-year window won’t be extended
Per the SECURE 2.0 Act, the typical penalty for missing a withdrawal is 25% of the amount that should have been taken out. Anyone that inherited a retirement account subject to the new regulations but failed to take distributions while waiting for the IRS’ final call will not be subject to that penalty. But those hoping the IRS would then give them more time to make distributions will likely be disappointed.
It is not anticipated that any more extensions are forthcoming, and, therefore, starting in 2025, individuals should be prepared to start taking annual withdrawals with the amount being determined on their life expectancy, which could help ease the pain of making a major payout due to missing four years of withdrawals.
4. Who is not affected: Some inheritors are not impacted by these regulations
The Secure Act sets forth classes of beneficiaries who are not subject to the 10 Year Rule. Those beneficiaries are those who are:
The spouse of the decedent
Less than 10 years younger than the decedent
Disabled
Chronically ill
Minor child of the decedent
Such beneficiaries have special rules affording them to stretch distributions over their life expectancy and not subject to the 10 Year Rule (a minor can stretch until age 21 and then are subject to the 10 Year Rule). Therefore, it is critical to assess the type of beneficiary inheriting a retirement account before guiding them on the distribution rules.
Additionally, the final regulations only apply to those beneficiaries of decedent retirement account owners who died after December 31, 2019.
5. Just because a taxpayer is only required to take a certain amount doesn’t mean they shouldn’t be taking more
In many circumstances, inherited IRA owners should have been imposing RMDs on themselves rather than waiting to see if the IRS makes them before the whole account needs to emptied out in year 10. This is because, for tax efficiency purposes, it is often better to spread out taxable income over the 10 years rather than wait for a very large taxable distribution in year 10. Therefore, inheritors should be observant of their tax situation when determining whether they should withdraw the minimum from their inherited retirement account or take a more aggressive approach.
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Please note, the information provided in this document is for informational purposes only and investors should determine for themselves whether a particular service or product is suitable for their investment needs. Please refer to the disclosure and offering documents for further information concerning specific products or services.
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