The Secure Act: Changes to the RMD Rules of Inherited Retirement Accounts

On December 20, 2019, President Donald Trump signed the Setting Every Community Up for Retirement (Secure) Act into law as part of the year-end spending bill.¹ The Secure Act (the “Act”) goes into effect on January 1, 2020 and makes a host of changes to retirement plan laws. Among these changes are significant changes to the required minimum distribution (RMD) rules for inherited retirement accounts.² It is these changes to the RMD rules for inherited retirement accounts which will likely have the biggest impact on estate planning and how planners incorporate retirement benefits into the overall structure of an estate plan. These provisions take effect for retirement plans of any individual who dies after December 31, 2019.³ For purposes of this article, I will discuss these new RMD rules as applied to individual retirement accounts (an “IRA”) but they are equally applicable to other qualified retirement accounts which are subject to §401(a)(9) including 401(k)s, 403(b)s, and other types of qualified retirement accounts.⁴

Primer on Stretch IRAs Prior to the Act

For individual IRA participants who die prior to January 1, 2020 and thus avoid the applicability of changes made by the Act, an inherited IRA can stretch out RMDs over the beneficiary’s life expectancy, provided certain requirements are met. In order to qualify for the stretch and avoid the mandatory five-year distribution rule under §401(a)(9)(B)(ii), the beneficiary of a retirement account in question generally must be a designated beneficiary as defined by Reg. §1.401(a)(9)-4 (a “Designated Beneficiary”)⁵ but there are special rules for spousal beneficiaries.⁶ Under the five-year rule, the beneficiary of the IRA must completely liquidate the IRA by the end of the five year period beginning on the date of death of the IRA participant.⁷ This can be accomplished in any manner the beneficiary chooses including a lump sum distribution on the final day of the five-year period. If the beneficiary is a Designated Beneficiary, then the RMDs may be distributed over the life expectancy of the beneficiary.⁸ If the beneficiary is not a Designated Beneficiary, then the five year rule under §401(a)(9)(B)(ii) is applicable.⁹ In general, the beneficiary must be an individual to qualify as a Designated Beneficiary.¹⁰ There is however an exception for certain qualifying trusts (a “See-Through Trust”) which satisfy certain requirements and allow the See-Through Trust to use the eldest beneficiary’s life expectancy for purposes of determining RMDs.

While a detailed discussion of the requirements and types of See-Through Trusts is beyond the scope of this article, a general overview may be helpful. There are two types of See-Through Trusts available for planners to use.  The first type is unofficially referred to as a conduit trust (a “Conduit”). A Conduit is derived from Reg. §1.401(a)(9)-5 A-7(c)(3), Example 2 and must pay out all IRA distributions directly to the beneficiary, hence the name Conduit as it serves only as a conduit to funnel distributions to the beneficiary. The second type of trust is unofficially referred to as an accumulation trust (an “Accumulation”). Any trust that does not meet the requirements for a Conduit above is an Accumulation. The term Accumulation, while unofficial, is used because the trustee has the ability to accumulate plan distributions in the trust. Both a Conduit and an Accumulation must meet the See-Through Trust requirements and must satisfy certain other requirements with respect to current and potential beneficiaries in order to qualify as a Designated Beneficiary and avoid triggering the five-year rule discussed above.

Stretching RMDs out over the beneficiary’s life expectancy often provided a powerful income tax deferral tool. For a regular IRA, stretching allows assets to continue to grow tax-deferred inside of the IRA prior to being distributed, only incur an income tax as required distributions are made, and completely avoid the 3.8% net investment income tax. For a Roth IRA, while stretching may not pack quite the same punch in terms of tax deferral, stretching allows assets to continue to grow tax-free (income tax and net investment income tax) while inside the IRA and are not taxable upon distribution, a result which may be even better than stretching a regular IRA.

Changes to RMD Rules of Inherited IRAs Made by the Act

The Act adds a new subparagraph (H) to §401(a)(9). The new subparagraph (H) revises §401(a)(9)(B)(ii) to change from five years to ten years, but only as to Designated Beneficiaries who are now subject to the ten-year rule rather than the stretch provisions as discussed below¹¹. Subparagraph (H) also eliminates the stretch provisions of §401(a)(9)(B)(iii) unless the beneficiary of the IRA is an “Eligible Designated Beneficiary”, a new term added to §401(a)(9)(E) by Act.¹² Eligible Designated Beneficiaries include the following individuals, if they otherwise fall within the definition of “designated beneficiary”:

• a surviving spouse;
• disabled individuals;
• chronically ill individuals;
• individuals less than ten years younger than the IRA participant; and
• minor children of the IRA participant (but only until they reach the age of majority, at which point the ten year rule becomes applicable).¹³

Where there is an Eligible Designated Beneficiary and the stretch rules are still applicable, if the benefits have not been distributed in their entirety at the Eligible Designated Beneficiaries death, remaining distributions can no longer be stretched over the beneficiary’s life expectancy, but must be distributed within ten years of the death of the Eligible Designated Beneficiary.¹⁴ The Act also does away with the distinction of whether the IRA participant had begun taking RMDs.¹⁵

So What Does This All Mean?

Let’s take a look how these statutory changes discussed above affect inherited IRAs.

The 5-Year Rule

The five-year rule under 401(a)(9)(B)(ii) still applies, and if the inherited IRA does not have a Designated Beneficiary, the proceeds of the IRA must be distributed out within 5 years of the death of the IRA participant. The new subparagraph (H) of the Act only applies to change the five- year distribution period to ten years where there is a Designated Beneficiary in which case the treatment is discussed below.¹⁶

Farewell to the Stretch IRA

For any individual IRA participant who dies after December 31, 2019, the option to stretch RMDs over the beneficiary’s life expectancy is no longer available due to changes made by the Act, subject to the Eligible Designated Beneficiary exception discussed above.¹⁷ The stretch provisions of §401(a)(9)(B)(iii) now only apply to an Eligible Designated Beneficiary.¹⁸ Where there is no Eligible Designated Beneficiary, but there is a Designated Beneficiary, §401(a)(9)(B)(ii) now requires all distributions to be taken out within ten years of the IRA participant’s death.¹⁹ These distributions may take place in any manner the beneficiary chooses including a lump sum distribution on the final day of the ten-year period.

Does it still make sense to use a “See-Through Trust” following the changes made by the Act?

In most cases, a See-Through Trust will only serve to delay distributions of an inherited IRA from five years to ten years. Whether a Conduit or an Accumulation is used, the primary difference will be whether the RMDs required to be distributed to the trust within ten years of the IRA participants death are then required to be distributed from the trust to the beneficiary, a requirement of a Conduit. This result that may not be desirable now that such distributions are no longer able to be stretched over a potentially lengthy period of time. Planners now have the option of naming a trust as the beneficiary of an IRA and avoiding the complexities that sometimes come with making sure a trust qualifies as a See-Through Trust, albeit at the possible cost of an extra five years of deferral. Nevertheless, the simplicity of not worrying about ensuring that a trust qualifies as a See-Through Trust and avoiding certain limitations that must be placed on a See-Through Trust may outweigh the benefit of an extra five years of income tax deferral via delayed distributions. Each situation is different, and every client’s needs and desires are different, so the answer to the question may very well be yes, but it is no longer as simple as it used to be.

How Will this Affect Planning?

With the ability to stretch RMDs of an inherited IRA over the life of a beneficiary no longer an option in most cases, planners will need to reconsider how they factor in IRAs to an overall estate plan, particularly where there are valid reasons to have a trust be the beneficiary for reasons such as asset protection, spendthrift protection, transfer tax reasons, and other benefits available to assets held in trust. Without an Eligible Designated Beneficiary, the tax man will come calling within ten years of the plan participant’s death. Planners should consider whether paying out the RMDs ratably over the ten-year period makes sense as opposed to taking a lump sum distribution at the end. Planners should also consider strategies to lower the overall effective tax rate including trust distributions that carry out distributable net income to a beneficiary to avoid paying income tax at the trust tax rate, but only if such distributions are in line with the overall goals of the estate plan.

Clients may want to rethink how their overall plan functions, especially where there are large retirement accounts involved. Planners should also review previously drafted estate planning documents which use a See-Through Trust to ensure the plan still functions as intended and achieves the client’s goals in light of the new changes made by the Act, particularly where a Conduit has been set up which may no longer function as intended.

Charles J. Allen, J.D., LL.M., CPA

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1. The entire spending bill can be found here (https://rules.house.gov/sites/democrats.rules.house.gov/files/BILLS-116HR1865SA-RCP116-44.PDF). Jump to page 1532 for the Secure Act.
2. See Section 401 of the Act, which begins on page 1640 of the link above.
3. Section 401(b)(1) of the Act.
4. Use of the § symbol refers to a Section of the Internal Revenue Code. The RMD rules are found in §409(a) and the related regulations.
5. Reg. §1.401(a)(9)-3 A-4(a)(2).
6. For purposes of this article, we will focus on non-spousal beneficiaries.
7. §401(a)(9)(B)(ii).
8. §401(a)(9)(B)(iii), (iv).
9. Reg. §1.401(a)(9)-3 A-4(a)(1), (2).
10. Reg. §1.401(a)(9)-4 A-1, A-3.
11. §401(a)(9)(H(i), (ii) as added by Section 401(a)(1) of the Act.
12. Section 401(a)(2) of the Act.
13. Id.
14. §401(a)(9)(H)(iii) as added by Section 401(a)(1) of the Act.
15. §401(a)(9)(H)(ii) as added by Section 401 of the Act. Note that this distinction previously determined what options were available for RMDs after the IRA participant’s death depending on whether or not the participant had begun taking RMDs prior to death.
16. §401(a)(9)(H)(i) as added by Section 401(a)(1) of the Act.
17. Section 401 of the Act.
18. §401(a)(9)(H)(ii) as added by Section 401(a)(1) of the Act.
19. §401(a)(9)(B)(ii), (iii), as revised by §401(a)(9)(H) as added by Section 401(a)(1) of the Act.