The 4 year wait is over! Understanding the
2020 SECURE Act Final Regulations from the IRS.

Who should read about these updates?

If you have an IRA or 401k (darn near everyone), at some point these changes will impact you. These are major shifts in how your Estate Plan will work.

It’s very likely that when you started these accounts, and/or had your last Estate Planning conversation, you discussed your demise as if your heirs could “spend” your accounts over their entire lifetime. That “lifetime” period of time is now in many or most cases reduced to 10 years, i.e. compress a lifetime of tax paid in to just 10 years. Broadly speaking, shorter time periods push income in to higher tax brackets.

If you’re a retiree or think these assets will pass to your heirs in the next decade or two, this is planning to tackle now.

Most of the scenarios we see are spouses inheriting IRAs (no change really) and adult children inheriting their parents IRAs (major change here). If your family is planning for one of these scenarios read on…

Why are you writing this in 2024?

Here’s a quick refresher on the (frustrating) timeline around this law…

• Late 2019 – Congress passes the SECURE Act
  • Congress can only speak in acronyms, so this is officially the Setting Every Community Up For Retirement Enhancement Act 😊.
• Early 2022 – IRS issues “Proposed Regulations” on how planners and consumers should approach RMDs in the new SECURE Act rules.
  • IRS waives penalties for not taking 2021 Required Minimum Distributions (RMDs) (which may or may not be required under as-yet not issued final regulations).
• 2022 – IRS waives penalties for not taking RMDs (which may or may not be required under as-yet not issued final regulations).
• March 2022 – Congress passes the SECURE Act 2.0.
  • This new law contains many new provisions around Retirement accounts and employer-sponsored retirement plans (like 401(k)’s, 403(b)’s, pensions, etc.), and a big delay in the starting age for RMDs.
  • The Nerdy world of CFPS’s still waits to correctly apply SECURE Act 1.0
• 2023 – IRS waives penalties for not taking RMDs (which may or may not be required under as-yet not issued final regulations)
• 2024 – IRS waives penalties… you get the idea
• July 2024 – IRS issues Final Regulations clarifying the practical application of the new RMD Provision in the SECURE Act from late 2019.

What You Need to Know About the IRS’s Final Regulations on Inherited IRAs

1. The 10-Year Rule: One of the most significant changes in these Final Regulations is the clarification of the new 10-year rule. Under the SECURE Act, most non-spousal beneficiaries must fully withdraw all funds from an inherited IRA within ten years of the original owner’s death. However, the final regulations introduce more nuance around RMDs during that 10-year period:

• If the original account owner had already begun taking RMDs (often called Required Post Beginning Date (RBD), so Post-RBD here), beneficiaries must continue taking annual RMDs during the 10-year period.
• If the original owner had not yet begun taking RMDs (Pre-RBD), the beneficiary can wait until the 10th year to withdraw the entire balance without annual RMDs.

2. Eligible Designated Beneficiaries (EDBs): The IRS’s final regulations also detail how this new category of beneficiaries can still stretch distributions over their lifetime, rather than adhering to the 10-year rule. EDBs include:

• Spouses
• Disabled or chronically ill individuals
• Beneficiaries not more than 10 years younger than the original account holder
• Minor children of the original account holder, although they must switch to the 10-year rule once they reach the age of majority (18 or 21 depending on the state).

3. Trusts as Beneficiaries: The final regulations provide much-needed clarity on how trusts that are named as beneficiaries should handle inherited IRAs. Two types of trusts are mainly affected:

• See-Through Trusts: These allow beneficiaries to stretch distributions according to their life expectancy, provided certain conditions are met.
• Conduit Trusts: Here, the RMDs are passed directly to the trust beneficiary, which can provide tax benefits but also requires careful planning.

4. Impact on Spousal Beneficiaries: The IRS has confirmed that spousal beneficiaries can continue to treat the inherited IRA as their own, allowing for more flexible distribution options. This means they can simply merge the inherited IRA with their own, or keep it separate, depending on their situation. This includes delaying RMDs until they reach the age of 73, the new age for starting RMDs under the SECURE Act 2.0.

Key Tax Planning Implications

These updates underscore the importance of long-range tax planning when it comes to inherited IRAs. Beneficiaries and advisors need to carefully review their options to minimize tax implications to their heirs. Here are some key considerations:

• IRAs (most impact to large IRAs) will be taxed in a much shorter period of time, which in many cases means more taxable income in each tax year, which generally means higher tax rates applied to those IRA withdrawals.
• Many individuals we work with inherit IRAs from their parents in their highest earning later working years, or often in early retirement years where taxable income is still high (Stock Plan vesting, deferred compensation payouts, consulting work, business ownership, farm income, part time work, spousal income, etc.).
• Small annual RMDs will be required from that IRA whether you want the taxable income or not. For most people this would be 2-4% of the inherited IRA that must be distributed and taxed in each of the 10 years.
• Taking the minimum RMD in each of the 10 years, then the large remainder in year 10, may not be the best tax strategy. Each situation is unique, “kicking the can down the road” is no longer a wise default for many families. For individuals with wealth over a couple million dollars, and/or with multiple sources of retirement income, a misstep here could cost 10-20% of your IRA paid to tax.
• ROTH accounts become more valuable than ever for many families. ROTH IRAs do not have an RMD during the 10 year rule, so you can let them grow for 10 years post-death with no issue. They are also permanently and completely tax free to your heirs from the moment you fund them. There are ways to get IRA money into ROTH IRAs, often at lower tax rates during life than after death. In many situations “prepaying” some tax on your IRAs will benefit your heirs immensely.
• This is crucial to talk through with an advisor who understands tax strategy very well (like Frazier Financial Advisors!). If your advisor has a disclosure in their email that says something like “… this cannot be considered tax advice…” their employer will limit their ability to give concrete tax advice and help you file your taxes through this complexity.

Final Thoughts

The SECURE Act, SECURE Act 2.0 and the IRS’s recent final regulations have introduced a new level of complexity to retirement planning, particularly for those inheriting IRAs. Staying informed and working with a true tax advisor to navigate these changes is crucial to maximizing the benefits of inherited retirement accounts.

For a deeper dive into these regulations, visit these Clark Schaefer Hackett’s and Kitces.com articles.