The Secure Act fundamentally changed the required minimum distribution rules for inherited IRAs and 401(k)s for tax years beginning in 2020 and thereafter. The law is perhaps best known for gutting the stretch IRA's tax deferral benefits for most beneficiaries. Now, the IRS has released proposed regulations interpreting those new RMD rules.
For most clients, a surprise twist in the regulations further reduces any remaining tax deferral benefits associated with the post-Secure Act stretch IRA — leaving clients to wonder whether any tax-efficient estate planning strategies exist to replace the stretch IRA. Those clients should know that options do exist, but each has its own set of tax rules that must be understood before taking action.
Secure Act Background
Prior to the Secure Act, individuals who inherited an IRA could stretch the tax deferral benefits over their own life expectancy. Today, only eligible designated beneficiaries (EDBs) have that option. EDBs include (1) surviving spouses, (2) disabled or chronically ill beneficiaries, (3) beneficiaries who are not more than 10 years younger than the original owner and (4) the original owner's minor children (until they reach age 21).
All other beneficiaries must empty the account within 10 years of the original owner's death — and pay the associated tax bill during that period. Prior to the regulations, most experts believed that the beneficiary wouldn't have to take RMDs in years one through nine, leaving the option of deferring taxes until year 10.
A surprise twist in the new regulations changed that for beneficiaries of accounts in "pay status." If the original owner died after their required beginning date (the date RMDs began), the beneficiary will also be required to take annual RMDs during years one through nine after death. Any remaining amounts must be distributed in year 10.
Increased Importance of Roth Conversions
The new regulations make the Roth conversion strategy even more appealing. The Secure Act also changed the rules for Roth IRA beneficiaries. If you inherit a Roth, you'll be required to empty the account in 10 years if you don't qualify as an EDB.
Roth IRAs, however, aren't subject to the RMD rules during the original account owner's life. Individuals who inherit Roth IRAs must take RMDs after the original owner's death — but that owner will always be deemed to have died before the account went into "pay status." Essentially, that's because a Roth can never go into pay status because there is no required beginning date — because the original owner didn't have to take RMDs during life in the first place.
So, even under the new regulations, any Roth IRA beneficiary can wait until year 10 to empty the account — allowing the funds to grow tax-deferred for another 10 years. Of course, those funds are nontaxable because the original account owner paid taxes on Roth contributions during life.
