Surprises With SECURE's 10-Year Rule

The SECURE Act is barely two months old. There has not been time for its provisions to be digested by advisors and administrators, let alone for the Treasury to issue regulations or even guidance. But some IRA owners and beneficiaries have died in the meantime, leaving fiduciaries to grapple with the bare statute. Here are some issues that fiduciaries are facing right now.

SECURE Applies to Some Deaths Before 2020 When Rodney died in 2008, he left his IRA to a "conduit trust" for the benefit of his daughter Eloise, who turned age 71 in 2009 (the year after the year of Rodney's death). Under a conduit trust, all distributions the trustee receives from the IRA (minus applicable expenses) must be paid out to the life (conduit) beneficiary as received. For minimum distribution purposes, Treasury regulations state that the conduit beneficiary is regarded as the sole beneficiary of the trust and of the retirement plan. Thus, the trustee was required to withdraw annual distributions from the IRA over Eloise's life expectancy of 16.3 years starting in 2009 and pass the distributions out to Eloise. The trustee faithfully did this every year through 2019.

Then SECURE was enacted at the end of 2019, and Eloise died in February 2020, before the trustee had withdrawn the 2020 required minimum distribution, or RMD, from the trust's inherited IRA. The trust instrument provides that, upon Eloise's death, any remaining trust assets shall be held for the benefit of Rodney's nephew Clarence to provide for his health, education, and support.

If SECURE had never been enacted, the trustee's job would have been to continue withdrawing annual RMDs over what was left of Eloise's original life expectancy, and to administer these distributions (after paying income taxes on them) for the benefit of Clarence. Since by 2020 there were only 5.3 years remaining in Eloise's original 16.3-year life expectancy, the inherited IRA held by the trust was pretty near its expiration date; its final distribution (under the rules before SECURE) would have come in the mid-2020s.

However, SECURE upended this prior treatment of inherited IRAs. Although SECURE generally applies only to IRA owner deaths after 2019, it also reaches back to change the rules for retirement benefits of pre-2020 decedents. Under SECURE's effective date rules, when the original designated beneficiary of a pre-2020 decedent dies, the "10-year rule" applies. This means the death of Eloise (Rodney's designated beneficiary) will be treated "as if" Eloise had been (under SECURE's post-2019 rules) an "eligible designated beneficiary" of the original owner of the IRA--meaning that SECURE’s 10-year rule now applies to what's left of Rodney's IRA.

The trustee asks a couple of very sensible questions about what it is supposed to do now. First, does the trust still have to withdraw the 2020 RMD based on Eloise's life expectancy? Second, is it possible the trust now has 10 more years over which it can draw down the IRA, even though under pre-SECURE rules it had only about five more years?

What Happens to the Year-of-Death RMD? Needless to say, we must wait for regulations to be sure of the answer on this one, but it would be a stretch to read SECURE as wiping out an RMD that had already accrued. SECURE is about accelerating distributions, not extending an already-due payout for 10 more years.

An inheritor seeking to spread out distributions over the maximum number of taxable years can take advantage of the year of death to accelerate some distributions, meaning that the "10-year period" will result in a potential 11 taxable years over which payments can be spread. But the 10-year rule's "official" payout period measures 10 full calendar years starting with the year after the year of death.

The law before SECURE presents no exactly analogous situation, since the "five-year rule" (on which the 10-year rule was based) applied only to deaths prior to the commencement of RMDs. However, in all cases where beneficiaries inherited an IRA from someone who was subject to taking RMDs, the regulations applied the "lifetime" RMD rules through the year of death and applied the post-death rules only to calendar years after the year of death.

It would be highly surprising if the Treasury adopted a different approach for SECURE's 10-year rule. To hold that Eloise's death wiped out the year-of-her-death RMD would punish people who took their RMDs early in the year. It is hard to imagine why Treasury or Congress would want to do that.

So, although we must wait for regulations to get the final answer, my bet is that the obligation to take the year-of-death RMD is not eliminated by death's insertion of the 10-year rule.

Did SECURE Really Lengthen the Payout Period? As noted, a curious result of SECURE (which is generally intended to accelerate post-death retirement plan distributions) is that the payout period would in some cases be lengthened as a result of the new law. In the case of Rodney's trust, the deadline for final distribution of the IRA to the trust has apparently been extended from approximately 2025 (the last year of Eloise's life expectancy payout period) until 2030 (year that contains the 10th anniversary of Eloise's death). Will Treasury regulations somehow overcome this effect, by installing a "shorter of" rule--the payout period will be the shorter of the original beneficiary's remaining life expectancy or 10 years? There does not appear to be any basis for the Treasury to do that, considering the statute's clear language, but the Treasury has broad latitude in establishing minimum distribution rules. Time will tell.

Where to read more: For the rule that a "conduit trust beneficiary is regarded as the sole beneficiary of the trust and of the retirement plan, see Treas. Reg. § 1.401(a)(9)-5, A-7(c)(3), Example 2. For how to compute the life expectancy of a designated beneficiary for purposes of determining required distributions under the life expectancy payout method, see Treas. Reg. § 1.401(a)(9)-5, A-5(c)(1). For the table used to compute beneficiary life expectancies for years prior to 2021, see Treas. Reg. § 1.401(a)(9)-5, A-6. For SECURE's effective date provision as applied to deaths before 2020 see § 401(b) of Title IV—Revenue Provisions of Division O (Setting Every Community Up For Retirement Enhancement) of the "Further Consolidated Appropriations Act, 2020."

Natalie Choate is an estate planning lawyer in Boston with Nutter McClennen & Fish LLP. Her practice is limited to consulting regarding retirement benefits. The new 2019 edition of Choate's best-selling book, Life and Death Planning for Retirement Benefits, is now 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 may or may not reflect the views of Morningstar.