SECURE Act 10-Year Mandatory Distribution Requirement for Inherited IRAs and 401(k)s Impacts Estate Plans

Estate planning for inherited IRAs and 401(k) became more complicated with passage of the Setting Every Community Up for Retirement Enhancement Act of 2019 — commonly known as the SECURE Act. The new law includes a requirement applicable to many inherited IRAs and 401(k)s that mandates full distribution of the account assets within 10 years of the account owner’s death. The rule applies to accounts inherited on or after January 1, 2020.

Previously, beneficiaries could withdraw assets over their life expectancy. The new rule significantly accelerates mandatory withdrawals for many inherited accounts, which substantially impacts the estate planning for those accounts.

The 10-year rule does not apply to a surviving spouse or to four other categories of beneficiaries. But unless your beneficiary fits one of those limited exemptions, the rule applies and likely affects your estate plan.

Which Beneficiaries Are Subject to Mandatory 10-Year Withdrawal From an IRA or 401(k)?

Most non-spouse beneficiaries who inherit an IRA or 401(k) in 2020 or later will be subject to the new rule. The five categories of “eligible designated beneficiaries” (EDBs) exempted from the 10-year rule include only the following individuals:

• Surviving spouse
• “Disabled” beneficiary, subject to a restrictive definition of “disabled,” under which the beneficiary must be unable to engage in “any substantial gainful activity” to qualify for the exception
• “Chronically Ill” beneficiary, also subject to a restrictive definition in the law
• Minor child of the account owner, who is exempted only the child reaches the age of majority (age 18 in Georgia), which triggers application of the 10-year rule
• Beneficiary not more than 10 years younger than the IRA owner

If a beneficiary meets the statutory requirements of one of these five EDB categories, the beneficiary is not subject to the 10-year rule and may withdrawal the assets over their life expectancy. However, if assets remain in the account when the EDB passes away, a successor beneficiary who does not fit one of the EDB categories will be subject to the 10-year rule.

Based on these narrow exceptions to the new rule, the change is of particular concern to anyone hoping that their children and grandchildren (or others not exempted) will benefit from IRA or 401(k) distributions over their lifetime.

How the New 10-Year Distribution Rule Impacts Your Estate Plan

If your IRA or 401(k) includes substantial assets, the accelerated withdrawal period for non-EDBs probably will significantly increase the tax liability of the beneficiary, since distributions are taxed as personal income in the year received. Larger distributions will mean a higher marginal tax rate in many cases. So, the government may end up with more of your hard-earned money.

The value of tax deferred growth over the lifetime of the beneficiary is lost as well. The higher amount distributions also make the assets vulnerable to creditors. (Please read our blog post Inherited IRAs Lose Asset Protection in Georgia for more details on this issue.) In addition, financial irresponsibility of the beneficiary is more of a risk, as is diversion of the assets as the result of a beneficiary’s divorce.

For minor children of the owner who inherit an IRA or 401(k) plan, the rule means that a child receives all the assets in the account by age 28. Few parents want their heirs to have control over substantial assets at such a young age. For grandparents, minor grandchildren who are not disabled or chronically ill (and so don’t qualify as an EDB) may receive the full distribution at an even younger age.

Fortunately, there are strategies and options for addressing all of these concerns. If you own an IRA or 401(k), the right solution depends entirely on your family and financial circumstances, as well as on the current structure of your estate plan. For anyone with an IRA or 401(k) in their estate, talking with an experienced estate planning attorney must be a top priority in the wake of these changes in the law.

In addition, it is crucial for individuals who own either type of account and rely on direct beneficiary designations to pass the account along should to talk with a qualified lawyer about making an estate plan. Even before the SECURE Act, other issues rendered direct beneficiary designations problematic in Georgia. With adoption of the new 10-year rule, having an estate plan should be a priority for anyone who owns an IRA or 401(k) account.

Other Changes for IRAs and 401(k)s

The SECURE Act does have two beneficial changes for owners of IRAs and 401(k)s. Both provisions recognize the reality that people are living and working longer.

First, prior law required an account owner to take the first required minimum distribution (RMD) by April 1 of the year after the owner turned age 70½. For account holders who turn 70½ in 2020 or later, the age increases to 72 years. (The prior rule still applies to anyone who reached age 70½ in 2019 or earlier.)

The SECURE Act also repealed the restriction on making contributions to an IRA or 401(k) after age 70½. As long as the account owner earns income to contribute, there is no longer an age restriction on making contributions.

Retirement and Financial Planning Considerations

Aside from the provisions relating to IRAs and 401(k)s, the SECURE Act includes numerous complex changes that affect retirement and financial planning and may warrant consulting with your financial planner. Among those modifications are provisions benefitting parents and small business owners.

New parents may now withdraw up to $5,000 from a retirement account without penalty within a year of the adoption or birth of a child. In addition, parents with a 529 plan are permitted to withdraw up to $10,000 without penalty to reimburse student loans. Other provisions make it easier for small business owners to start a retirement plan or join a multiple employer plan (MEP).

The SECURE Act is very complicated. All the new rules include detailed criteria. If you are affected by any of them, your best strategy is to discuss the new law with a legal or financial professional (or both) before you make any decisions or take action.

Talk With a Trusted Georgia Estate Planning Attorney About Your IRA or 401(k)

Our Cartersville estate planning practice at Asset Protection & Elder Law of Georgia focuses on helping clients find solutions for many challenging circumstances involving their assets, families, and estates. Our work includes assisting in estate plan modifications necessitated by significant changes in the law like those in the SECURE Act.

We provide a broad range of legal services to clients throughout the communities northwest of Atlanta, including in Bartow County, Cobb County, Cherokee County, Gordon County, Floyd County and Paulding County.

To schedule a consultation, call us at (770) 382-0984 or contact us through our online form.