The Secure Act, RMDs, and Beneficiaries: Another Wrinkle

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In my July 2021 column, I provided a detailed “Executor’s Roadmap” for determining the post-death required minimum distributions, or RMDs, applicable to the decedent’s beneficiaries. I was sure I’d covered every scenario, but it turns out I left out a big chunk of inherited benefits: benefits that were originated by an employee or IRA owner (the “participant”) who died prior to the effective date of the Secure Act. Sorry about that! Here’s what you need to know for the current holders of benefits inherited from a pre-Secure decedent.

The Setting Every Community Up for Retirement Enhancement Act changed the minimum distribution rules for inherited retirement accounts, almost eliminating the "life expectancy payout" that had prevailed since 1986. From now on, only "eligible designated beneficiaries" would be entitled to a life expectancy payout; all other designated beneficiaries would be stuck with the 10-year rule. The law stated it would apply to benefits inherited from a participant who died after 2019.

Beneficiaries of decedents who died before 2020 could continue to withdraw using the life expectancy payout that had applied when the original owner of those benefits had died. That makes our first case simple:

Mater Example. Mater died at age 91 in 2018 (that is, before the Secure effective date), leaving her IRA to her son Junior as her designated beneficiary. Junior reached age 67 on his birthday in the year of Mater's death, so his age on his birthday the following year (2019) was 68. His life expectancy at age 68 was 18.6 years, so his first RMD, in 2019, was the Dec. 31, 2018, year-end account balance of the IRA divided by 18.6 years. (Of course he also had to withdraw, in 2018, the balance of the 2018 RMD if Mater had not fully withdrawn it prior to her death.)

As Mater’s death was pre-2020, Junior will just keep withdrawing RMDs based on his single life expectancy, reduced by one each year, until the account is reduced to zero, as if Secure had never happened. There are a couple of wrinkles to this, of course: There was no RMD in 2020 (because of the Cares Act, which waived RMDs for everybody that year), and in 2022 he will have to switch to the new IRS life expectancy tables just like the rest of us. Despite wrinkles, we can foresee that this account may make its final distribution in 2038 or thereabouts if Junior takes full advantage of the life expectancy payout.

But this IRA is not necessarily forever. Yes, Secure’s legacy exception applies to the designated beneficiary of a participant who died prior to Secure’s effective date (Jan. 1, 2020). However, it ceases to apply upon the death of “such employee’s designated beneficiary who dies after such date.” In other words, whoever inherits this account after the post-Secure death of the original designated beneficiary does not get to “step into the shoes” of the deceased designated beneficiary and withdraw over what’s left of the original designated beneficiary’s life expectancy. That was the old pre-Secure treatment of successor beneficiaries. Under the new post-Secure regime, the payout "flips" to the 10-year rule upon the post-Secure death of the original designated beneficiary.

As Secure puts it, the successor beneficiary of the deceased original designated beneficiary will be treated the same way Secure treats the successor beneficiary of an “eligible designated beneficiary”: The life expectancy payout ends, and the payout instead flips to the 10-year rule at that time.

Suppose Junior (who was Mater’s designated beneficiary) dies in 2021 (after the effective date of Secure). The account now passes to Junior’s successor beneficiary. His successor beneficiary could be someone he named as successor beneficiary in forms provided by the IRA provider, or it could be his estate (which typically would be the “default successor beneficiary” if the beneficiary of the IRA dies after inheriting the account but prior to having withdrawn all the benefits and without naming a successor). As always, the successor beneficiary must take the RMD for the year of death (2021) to the extent that Junior had not taken it prior to his death. Then, according to this limited rule, annual RMDs cease, and the successor beneficiary must withdraw 100% of the balance of the account under the “10-year rule”--that is, by Dec. 31 of 2031, the year that includes the 10th anniversary of Junior’s death. Subject to IRS Secure regulations (which have not been issued yet), that seems to be how it works.

Now on to less obvious situations. Based on Secure's language, it appears that the life expectancy payout of a pre-2020 decedent's account is legacied "forever" if the original account owner and his/her designated beneficiary both died prior to 2020:

William Example: William died in 2013 (that is, prior to Secure), leaving his IRA to his friend Kathy as designated beneficiary. Kathy started withdrawing the account over her 23-year life expectancy, but then, in 2018, she also died. The IRA then passed to her successor beneficiary, her son Alec. Under pre-Secure law, Alec was entitled to continue withdrawing over what was left of Kathy's life expectancy (about 18 years). As we have seen, under Secure, if Kathy had died after Secure's effective date, the payout would flip to the 10-year rule upon her death, thus terminating Kathy's life expectancy payout and replacing it with a 10-year rule. However, that flip applies only to the successor beneficiary of "such employee's designated beneficiary who dies after such date"--that is, after 2019 (emphasis added). In this case, both the original IRA owner (William) AND "such employee's designated beneficiary" (Kathy) died before the Secure effective date. Thus, it appears that this account should be totally exempt from Secure, and Alec can continue withdrawing over what's left of Kathy's life expectancy. He should never have to flip to the 10-year rule. We await Treasury's Secure regulations to see whether they agree with this conclusion.

Finally, there is one more significant gap in Secure’s legacy exemption for pre-2020 deaths: How does the rule apply when the original “designated beneficiary” was a “see-through trust” with multiple beneficiaries rather than one individual person?

Dolly's IRA Example: Dolly died in 2010, leaving her $1 million IRA to a trust for the benefit of her six grandchildren. The trust provides that the trustee is to use income and principal as the trustee deems advisable for the health, care, education, and support of the grandchildren until there is no grandchild living who is under the age of 35, or there is only one grandchild living, whichever comes first, at which time the remaining trust balance is to be distributed to Dolly's then-living issue by right of representation. The trust qualifies as a "see-through trust" under the IRS' minimum distribution trust regulation, and accordingly qualified as Dolly's "designated beneficiary." The trust has been taking annual RMDs from the IRA based on the 53-year life expectancy of the oldest grandchild. In 2021, one of the younger grandchildren dies; the other five are still living.

Because Dolly died before 2020, the trust is entitled to continue the life expectancy payout under Secure’s legacy exemption rule. We know this life expectancy payout must flip to the 10-year rule upon the post-2019 death of Dolly’s “designated beneficiary.” But in this case, there are multiple designated beneficiaries and only one of them has died. Does the flip occur now--upon the first death in the group--or not until all six grandchildren are deceased? Or only upon the death of the oldest grandchild, whose life expectancy is the measuring period for RMDs to the trust?

In my opinion, the flip should not occur until all “designated beneficiaries” who were living at the time of participant’s death have died. Pre-Secure Treasury regulations, in effect since 2002, specified which beneficiaries of a trust would be “countable” as beneficiaries of the retirement account and which could be ignored as “mere potential successors.” Only if all countable beneficiaries were individuals (among other requirements) would the trust qualify as a see-through trust entitled to the life expectancy payout (Reg. § 1.401(a)(9)-5, A-7(c)(1)). All such countable individual beneficiaries are “designated beneficiaries” and the life expectancy of the oldest one of them would be the applicable distribution period for the trust. However, some IRS statements suggest that only the oldest trust beneficiary is considered the participant’s “designated beneficiary.”

The trustee of Dolly’s trust should presumably continue taking RMDs using the existing (pre-Secure) life expectancy payout arrangement, until the IRS issues regulations clarifying exactly when (if ever) this trust will have to flip to the 10-year rule.

Natalie Choate is a lawyer in Wellesley, Massachusetts, who concentrates in estate planning for retirement benefits. The 2019 edition of Choate's best-selling book, Life and Death Planning for Retirement Benefits, is available through her website, www.ataxplan.com, where you can also see her speaking schedule and submit questions for this column. The views expressed in this article do not necessarily reflect the views of Morningstar.