At Last, IRS Issues Final Regulations on SECURE Act, Inherited IRAs

The IRS issued long-awaited final regulations on the Setting Every Community Up for Retirement Enhancement (SECURE) Act, enacted in late 2019. The final regs generally follow the proposed regulations issued in 2022, discussed in the May and June 2022 issues of Retirement Watch.

The IRS kept the most controversial rule in the proposed regulations, its interpretation of the new 10-year rule on inherited IRAs and other retirement accounts.

The SECURE Act eliminated the Stretch IRA for most beneficiaries of IRAs, 401(k)s, and other defined contribution retirement accounts, though I’ll generally refer to IRAs. Under previous law, annual required minimum distributions (RMDs) had to be taken by beneficiaries, but the RMDs often could be stretched over a beneficiary’s life expectancy.

The Stretch IRA was replaced by the 10-year rule. Most IRAs inherited after 2019 must be fully distributed within 10 years.

Here’s where the IRS regulations are complicated and controversial.

The regulations divide inherited retirement accounts into two groups: those whose deceased owners had not reached the beginning age for taking RMDs and those whose owners had reached that age.

A beneficiary in the first group can distribute the IRA under any schedule, as long as it is fully distributed by the end of the 10 years. The beneficiary can distribute some each year, wait until near the end of 10 years to distribute it all, distribute the entire IRA soon after inheriting, or in any other pattern.

The rules for the second group are more complicated.

During years one through nine after inheriting, the beneficiaries must take RMDs until the IRA is empty or the 10-year period ends, whichever comes first. The beneficiary can take more than the RMD amount in any year, but must take at least that amount in years one through nine. The entire IRA must be distributed by the end of year 10.

The SECURE Act’s 10-year rule applies to both traditional and Roth accounts. It also applies to 401(k)s and most other defined contribution retirement accounts.

Original owners of Roth IRAs don’t have to take RMDs, so their beneficiaries never have to take RMDs during years one through nine. They only need to distribute the entire Roth IRA by the end of year 10.

Because the requirement to take RMDs in years one through nine arose in proposed regulations and was controversial, the IRS suspended the requirement for 2021-2024. Penalties for failing to take those RMDs are waived.

The annual RMDs don’t have to begin until 2025, and beneficiaries don’t have to make up RMDs that weren’t taken from 2021 through 2024.

But the 10-year rule applies without change. Most retirement accounts inherited after 2019 must be fully distributed within 10 years after being inherited.

For example, Max Profits died at age 80 in 2020 and named his son, Hi, as beneficiary of his traditional IRA.

Hi must fully distribute the IRA by December 31, 2030.

In addition, Hi must take annual RMDs through 2030 or until the entire IRA is depleted, whichever occurs first. Hi didn’t take RMDs in 2021 through 2024.

Hi must begin RMDs from the inherited IRA in 2025 and must take RMDs each year through 2029. The balance of the IRS must be distributed by the end of 2030 or sooner.

Hi computes the RMDs using his life expectancy from the Single Life Table in IRS Publication 590-B.

Here’s where the computations become very tricky for anyone who inherited an IRA from 2020 through 2024.

Suppose Hi turned 60 in 2020. Because of the IRS’s waivers, he doesn’t have to take the first RMD until 2025.

To compute that RMD, Hi uses the current life expectancy tables to determine his life expectancy in 2021 when he was 61. That’s the year after Max died and the first year an RMD would have been required without the IRS’s waivers. Then, Hi subtracts 1.0 for each year after that.

Life expectancy for a 61-year-old in the tables is 26.2. Subtracting 1.0 for each subsequent year brings Hi to a life expectancy of 22.2 in 2025. He divides the IRA balance on December 31, 2024, by 22.2 to arrive at the RMD for 2025.

For each year after that, Hi subtracts 1.0 from the previous year’s life expectancy to arrive at the current year’s life expectancy and compute the RMD.

Hi must distribute all of the IRA by the end of 2030. Remember, Hi always can take more than the year’s RMD and deplete the IRA before 2030.

There’s a break for a beneficiary who is older than the deceased IRA owner was. The beneficiary can use the greater of his or her life expectancy and the deceased owner’s life expectancy. So, the beneficiary can continue taking RMDs under the deceased owner’s schedule instead of taking higher RMDs using his or her life expectancy.

The 10-year rule really is an 11-year rule, because the count doesn’t start until the year after the original IRA died. When annual RMDs are required, the beneficiary must take the first RMD by Dec. 31 of the year after the original owner passed away.

The regs also clarify the rules for minor beneficiaries. The 10-year rule doesn’t apply to an IRA beneficiary who is under 21. But once the beneficiary turns 21, the 10-year count starts.

Also, if the original IRA owner had reached the RMD beginning age at the time of death, the beneficiary must take RMDs after turning 21. So, the beneficiary must take annual RMDs from ages 21 to 31, or until the IRA is depleted.

For all inherited IRAs, if the original beneficiary passes away and there’s a successor beneficiary, the successor continues the same 10-year period as the original beneficiary. Plus, if the original beneficiary was taking RMDs, the successor must continue that schedule or deplete the IRA even faster.

There is more about the SECURE Act in the final regulations (they’re 260 pages), and the IRS at the same time issued regulations covering parts of the SECURE Act 2.0. I’ll probably have more details from the regulations in the next issue of Retirement Watch.

The RMD rules should be a beneficiary’s second priority. The main focus should be on taking distributions to minimize lifetime income taxes.