Secure Act Proposed Regulations Impact Planning for Inherited Retirement Accounts

By Attorney Sam Azinger

In January 2020 the Setting Every Community Up for Retirement Enhancement (“SECURE”) Act made substantial changes to distribution rules for death benefits payable from an individual retirement, 401(k), profit-sharing, or 403(b) account (hereinafter qualified retirement accounts or “QRAs”).  For a refresher on these changes see this Wisconsin Lawyer Article authored by Andrew J. Willms and Maureen L. O’Leary and published in May, 2020 edition of the Wisconsin Lawyer.  

More recently, in February 2022, the IRS issued proposed regulations on its interpretation of the SECURE Act as it relates to the distribution rules for inherited qualified retirement accounts.  Over 150 comments on the proposed regulations were submitted to the IRS by the May 25, 2022 comment submission deadline.  This article summarizes selected key provisions of the proposed regulations in their current form. 

Change From Stretch Rule to 10-Year Rule Under the SECURE Act

As a refresher, the SECURE Act changed the rules for a beneficiary that is an individual or qualified look-through trust (a “Designated Beneficiary”).  After the SECURE Act, the old rule allowing the Designated Beneficiary to stretch distributions over the lifetime of the beneficiary based on the life expectancy of the beneficiary (referred to as the “stretch rules”) was replaced with the requirement that the inherited QRA be distributed to the beneficiary in its entirety within 10-years after the original QRA owner’s death (referred to as the 10-year rule).  

A non-Designated Beneficiary (such as an estate or non-qualified look through trust) still follow the old pre-SECURE Act rules discussed further below (these are referred to as the “no-DB rules”). 

IRS Interpretation Under Proposed Regulations (10-Year Rule AND Stretch Rule)

Under the proposed regulations, the IRS has taken the position that in some instances the beneficiary of an inherited QRA must apply the 10-year rule and must apply the stretch rules during the 10 years period prior to withdrawing the balance of the account.  In other words, in some circumstances the beneficiary can’t wait until year 10 to withdraw the full account balance. 

The proposed regulations create two categories of inherited QRAs with different rules.  One category is when the QRA owner died on or after their required beginning date (RBD), and a second category is when the owner died before their RBD.  (The RBD is the deadline by which an individual must start taking require minimum distributions from a retirement account.)

  1. Treatment when Owner Died Before Required Beginning Date

If the QRA owner died prior to their RBD, only the 10-year rule would apply to a Designated Beneficiary.  The Designated Beneficiary would not be required to also apply the stretch rules during the 10-year period but would still need to withdraw the entirety of the QRA no later than the year containing the 10-year anniversary of the QRA owner’s death. 

Under the no-DB rules, if the QRA owner had not reached their RBD, non-Designated Beneficiary would need to withdraw the entirety of the QRA no later than the year containing the 5-year anniversary of the original QRA owner’s death.  

  2. Treatment when Account Owner Died on or After Required Beginning Date

Under the proposed regulations, if the QRA owner died on or after their RBD, both the 10-year rule and the stretch rules would apply during the 10-year period for a Designated Beneficiary.  However, under the no-DB rules when the QRA owner died on or after their RBD, the beneficiary could apply the stretch rules based on the life expectancy of the original QRA owner.  

Prior to the SECURE Act, there were very rare instances in which intentionally triggering the no-DB rules would have been advantageous.  However, after the SECURE Act, there are instances in which intentionally triggering the no-DB rules would allow for the beneficiary to annuitize the benefits over a longer period of time than 10 years, allowing the beneficiary to minimize income and continue to receive tax free growth inside the QRA.  

Conclusion

Planning for QRAs is an important component of a comprehensive estate plan, and planning for how to address distributions from a QRA before and after a death is a complex analysis that should be undertaken with professional advice.  Please let me know if you would like to review and discuss how your estate plan addresses qualified retirement accounts.  You can reach me by email at sazinger@olglawoffice.com.