Inherited IRAs after SECURE

Theresa:
Hello and welcome to another episode of Wealth Planning Illuminated. I’m your host, Theresa
Marx, a Senior Wealth Strategist at CIBC Private Wealth in the US. I am joined today by my
colleague Caroline McKay, also a Senior Wealth Strategist at CIBC Private Wealth. In today’s
episode, Caroline and I will discuss inherited IRAs after the Secure Act. In particular, we will
take a look at the beneficiary classifications and the withdrawal methods that now apply under
secure. Alright, with that, let’s get started.
When the Setting Every Community Up for Retirement Enhancement Act, or better known as
the Secure Act became effective on January 1st, 2020, the rules for how inherited IRAs must be
withdrawn changed significantly. The Secure Act, along with some subsequent notices and
proposed regulations from treasury, have led to many questions on just how someone is
supposed to withdraw an inherited IRA when they are the beneficiary of that IRA. So Caroline, I
thought we could talk through the rules that apply when someone is trying to determine when
they must withdraw assets from an inherited IRA. But first I do think it’s important that we note
that the rules we’re going to talk about today really only apply to inherited IRAs where the owner
died on or after January 1st, 2020. So for inherited IRAs that were in existence before that,
because their owner died before January 1st, 2020, the old rules were generally the beneficiary
could withdraw assets from an inherited IRA over their own life expectancy. Those rules
continue to apply for those older inherited IRAs. So we’re really focused today on the new, if you
will, inherited IRAs for owners that died on or after January 1st, 2020. So with that little caveat,
let’s start with the types of beneficiaries that came up under secure because I think it’s really the
beneficiary type that ultimately helps us decide the distribution method. So if you could get us
started with what types of beneficiaries, how do we classify a beneficiary?
Caroline:
Yes, absolutely. So as you said, how long someone has to withdraw money from an inherited
IRA is going to depend on their beneficiary classification. I’m going to put out some technical
terms here that the IRS has defined because that if you have ever inherited an IRA or will inherit
an IRA, these terms will be used quite often. So it’s important to understand the differences. So
the first type of beneficiary is called an eligible designated beneficiary, and the people who fall
into this category include the participant surviving spouse, so the IRA owners, surviving spouse,
minor children of that account owner disabled or chronically ill individuals who have been
named as a beneficiary or beneficiaries who are less than 10 years younger than the deceased
account owner, which also happens to include people who are older than the account owner. So
it seems fairly broad, but in most of our cases, surviving spouses, absolutely we see that very
often. Outside of that though, it’s less often that we might see minor children inheriting or
disabled or chronically ill individuals. So eligible designated beneficiaries is sort of a limited
class of people
Theresa:
And I think it’s important the minor children kind of eligible designated beneficiary. We get that
question a lot. I think when people sometimes think, oh, if my grandchild is a minor then I can
leave it to them and that will qualify. But I think what you said was important. It’s the minor child
of the owner. It’s not just any minor child.
Caroline:
That is absolutely right. So it is more limited than it might sound off the cuff. So any person who
does not fall into this eligible designated beneficiary category is now known as something called
the designated beneficiary, and that’s a much larger group in terms of when we see people
naming beneficiaries of their IRAs. If it’s not the surviving spouse, oftentimes it might be an adult
child or a grandchild, both of whom typically are going to fall into this designated beneficiary
category. They’re not going to be considered an eligible designated beneficiary. And then the
final category is something called a non-designated beneficiary. So if you’re not eligible
designated beneficiary and you’re not the designated beneficiary, you fall into this designated
beneficiary category, which is sort of a tongue twister when you try to say it now. And that is a
beneficiary who really is typically an entity and not an individual. So let’s say you didn’t name
anybody as the beneficiary of your IRA by default, it then flows into your estate. Your estate is
not a person, so thus it’s considered the non-designated beneficiary. Same with a charitable
organization or a non-qualifying trust. So those high level are the three types of beneficiaries
that help us determine how long the beneficiary has to withdraw funds from the account.
Theresa:
So now that we know what different types of beneficiaries that there are, I think our next
question really is what are the distribution methods available to different types of beneficiaries?
So one of the most common ones we see is of course a spousal transfer. So can you walk us
through that and the options in a spousal transfer?
Caroline:
Sure. So if someone has named their spouse as the primary beneficiary of their account or even
a partial beneficiary of the account, that spouse sort of has the broadest options in terms of the
distribution methods. So they are falling into this eligible designated beneficiary category, and
because they’re a spouse too, they are provided even more benefits as sort of this special
classified person. So a surviving spouse has the option to either inherit the IRA and take
distributions over the life their life expectancy, or they can actually transfer the IRA into their
own personal IRA effectively combining it or treating it as their own personal IRA, which has the
benefit of now required. Minimum distributions are determined based on that spouse’s age. So if
they’re younger than the account owner, when the account owner died and maybe is not subject
to A RMD yet, they could delay it. They can name their own beneficiary. So spouses really have
two options. They can follow sort of an inherited IRA methodology, which requires them still to
take RMDs over their life expectancy, but they don’t get to name a following successor
beneficiary and things like that. Or they can roll it into their own IRA and treat it as if it was
always their money, which is a be that no other beneficiary has under these IRA rules.
Theresa:
And I think it’s probably the most common that we see a surviving spouse doing that spousal
transfer, treating it as their own, it becomes their own account. I think it’s just simpler in a lot of
ways, but also has the benefit, as you said, kind of spreading it out over their life expectancy
and their age, really determining those RMDs.
Caroline:
Yeah, and the only time again we consider other options is when there’s maybe an age disparity
between the account owner who died and the spouse. There are sometimes some benefits for
doing it one way versus the other, but you’re absolutely right. In almost all cases we typically
see the spousal transfer.
Theresa:
So you mentioned the life expectancy method. Can you walk us through what that is and into
what beneficiaries that method might apply?
Caroline:
Sure. So the life expectancy method says that the beneficiary who is eligible to use this method
can take distributions over their life expectancies. RMDs in that case start pretty much right
away one year after the death of the account owner. And again, the only thing that has to be
taken out every year is this required minimum distribution based on the age of the beneficiary in
the year following the death of the account owner. That was sort of the rule under pre secure
that most people know this is the life expectancy method. The big difference post secure act is
that this life expectancy method is typically only available to this eligible designated beneficiary
category. So it’s a smaller population of people that have this option, but the life expectancy
method effectively just gives the person who’s inheriting it, who qualifies distribution over their
life, which just allows the money oftentimes to stay in the protection of the IRA account in terms
of not having to pay taxes inside the IRA for a longer period of time.
Theresa:
This is one of those methods that I think it’s important to note too, that it applies not only to a
traditional IRA that you’re inheriting, but also to a Roth. I think we sometimes think of a Roth IRA
as having this never have to take distributions, but under the life expectancy method, the Roth
IRA would have to start coming out over that period. Correct.
Caroline:
That’s absolutely true. So while the owner of a Roth account does not have to take RMDs under
the life expectancy method, somebody who has inherited the Roth IRA would have to take
RMDs over their life expectancy. That’s absolutely correct.
Theresa:
So I think we’ve mentioned it a couple times that really one of the biggest changes with secure
was this introduction of the 10 year method where we went from the stretch life expectancy
method to the 10 year method. So can you walk us through the 10 year method and what that
means for a beneficiary and who it might apply to?
Caroline:
Sure. So the 10 year method applies or requires that the entire IRA account be distributed by
December 31st of the 10th year following the account owner’s death. So the 10 year rule is
okay, you only have 10 years in which to remove all of the money. And again, this rule is sort of
the now default rule for everyone in that designated beneficiary category that is going to
primarily if you think about if an adult child is inheriting the count or even a grandchild, because
remember we talked about that minor child rule doesn’t apply to grandchildren, most people
outside of these eligible designated beneficiaries are going to have this 10 years. And of course,
because nothing is simple with treasury and the IRF, there’s sort of two aspects of the 10 year
method. One piece of the 10 year method is if the account owner died before their required
beginning date, which is essentially the date where they have to start taking RMDs. So currently
that age is 73, right? So if the account owner and our examples for 2024 died before they turned
73 and were not taking required minimum distributions, let’s say their adult child inherits the
account, that child has up to 10 years to make distributions and they can take it all in year 10 or
they can take it piecemeal over the 10 years. It’s really up to the beneficiary how much they
withdraw during that 10 year period. But it all has to come out at the end of the 10th year.
Theresa:
So they’re not required to take one 10th out every year or any sort of required minimum
distribution. They have the freedom to look at their own cashflow and figure out what makes the
most sense as long as it comes out by that end of the 10th year.
Caroline:
That’s absolutely correct. Then the second piece of this 10 year method is for rules related to if
the account, sorry, the account owner died after that required beginning date. So in my
example, if we’re using age 73 as the starting date for when you have to take RMDs, if the
account owner died after that date, then we have these proposed regulations that say that these
designated beneficiaries over the 10 years that they have to withdraw the at entire account, they
also have to take required minimum distributions based on their age. So it’s a little bit of a
confusing rule and sort of through the planning world for a loop because when we first heard the
10 year rule, we all thought, great, you have 10 years to take out the money and you take it out
as you want. Then treasury came out with these proposed regulations saying Actually if you
died after this required beginning date, we read the statute to say that you have to take these
RMDs over the 10 year period.
The hard part right now is that these are still proposed regulations and have not been finalized
and so far over the last couple of years, the IRS keeps putting out notices saying, okay,
proposed regulations haven’t been finalized and we’re going to allow someone to avoid taking,
you won’t be penalized for not having taken a required minimum distribution. Those notices
have gone now through 2023. We do not have anything yet in 2024 indicating whether that rule
of having to take an RMD will be punted or will start applying. So if you happen to be listening
and you have an inherited account of someone who died between 2020 effectively and today,
you should be paying attention and working with your tax advisor or financial advisor to
understand when you might have to start taking this required beginning minimum distribution.
Theresa:
So it sounds like once you know what type of beneficiary you are and if you fall within this 10
year rule, the next question is, okay, did the owner die before that required beginning date or
after that required beginning date? And if it’s after, it’s kind of still asking yet another question is
what has the IRS said or has Treasury told us more to either finalize those regulations or kind of
punted it down the road again?
Caroline:
That’s absolutely true. So it is very complicated. You can tell probably from just what we’ve
talked about before. So it is important to understand what date did the person die, the account
holder died, what beneficiary classification you’re in, and if you’re falling into this 10 year rule,
you need to know again whether the person was taking RMDs or not. And if we have a Roth,
there is no beginning date for a Roth because no required minimum distributions are ever
required for an account holder. So if you happen to inherit a Roth IRA and you’re subject to this
10 year rule, you get a little bit lucky and know that you just have 10 years to take out the
money. You don’t have to worry about taking potentially a required minimum distribution.
Theresa:
Okay. So one more method other than just taking the whole account and taking a lump sum
distribution, but the five-year method, and this is one that was pre-secure as well for certain
beneficiaries and it still applies today. So what is the five year method?
Caroline:
Yeah, so the general rule for the five-year method is if you are one of these classifications of
non-designated beneficiaries, so a non-qualifying trust, an estate, a non-person is inheriting, the
general rule is they have five years to take out the money from the IRA and then of course
because nothing is simple, there is a caveat that again, if the account owner died after the date
that they were taking required minimum distributions, there’s actually a life expectancy method
that’s used. Again, we find that less, it’s more rare that we see the five-year rule being imposed
because most people have named individuals or qualifying trusts as the beneficiary of their
plans. Really when you worry about this five year method or this sort of pseudo life expectancy
method is if you fail to name somebody as a beneficiary is most often when it comes up,
Theresa:
But it’s within a state in particular because if it’s a charity, a charity really doesn’t care as much
about the withdraw method because they don’t pay the income taxes. So I do think it happens
most within a state because somebody forgets to name a beneficiary for their accounts.
Caroline:
Yeah, absolutely.
Theresa:
So just real quick, we’ve mentioned a couple of times RMDs and if somebody has to take an
RMD and as a caveat, these are very complicated rules. There are charts and things, but can
you just on it just to wrap it all together in a nice little bow, what are we looking at when we’re
thinking about RMDs for an inherited IRA?
Caroline:
So the way we calculate an RMD associated with an inherited account when it applies and we
need to calculate it, it’s based off of the account value as of December 31st of the previous
calendar year. And then you divide that or yeah, it’s divided into a life expectancy factor that the
IRS provides and anybody who has a retirement account, they may be somewhat familiar with
RMD calculations because in some ways it is very similar. The one big caveat is the life
expectancy factor is different based on when you’re, if you’re alive versus if you’re inheriting an
account primarily, and there’s some caveats here, but primarily when we’re calculating RMDs
with inherited accounts, for the most part we’re using a single life expectancy table. So it’s
factoring just one person’s life. We look at the beneficiary’s age, the year following death, there’s
a table that gives us a life expectancy factor.
Let’s say they expect based on that person’s age that the person will live 30 years. So year one,
your life expectancy factor is 30 every year thereafter that an RMD is being calculated. We take
that 30 years and we just subtract one. So every year it’s one less. That’s a little bit different
than when you’re alive and you’re having your RMD calculated. That type of RMD when you’re
alive is typically based off of a different life expectancy table that usually anticipates that there’s
a second person, like a spouse involved. So the life expectancies tend to be greater. I
mentioned that only because Theresa, you and I have both been part of many questions related
to people looking at life expectancy factors on an inherited account and then looking at their
own IRA and saying, why are they so different? And that explains it because we mentioned
earlier that surviving spouses sort of are the special classification. The life expectancy factors
for spouses are a little bit different than what I just mentioned and tend to be, again, a little bit
better in terms of having longer life expectancies. But that’s sort of the highest level. I can
explain it with that going too deep into the weeds.
Theresa:
But so if I am an owner of my own IRA taking RMDs and I’m a beneficiary of an inherited IRA
taking RMDs, I shouldn’t be surprised if I see that my life expectancy is different between those
two accounts because it’s a different table. It’s a different
Caroline:
Approach. Exactly right.
Theresa:
Alright, so thank you so much for walking us through these. You said there are so many
nuances and we both have been part of many conversations with clients that there’s just one
little difference and it changes the whole analysis. So I do think it’s really important, everybody
listening to this, if you have an inherited IRA in particular, look at your particular circumstances,
talk to your financial advisor. As soon as you hear that you’ve inherited an IRA, start working
with your advisors to really make sure you know what method you fall under, what type of
beneficiary you are to make sure you’re following the rules that apply to your particular inherited
IRA that you are as a beneficiary. So we hope this has been helpful as we navigate these post
secure rules. Thank you so much.
Thank you for joining us for this episode of Wealth Planning Illuminated. We hope you found this
topic interesting and that you will continue to explore the variety of wealth planning topics
available to you on this channel. Thank you and have a great day.
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