Don’t be fooled by the name Congress gave to the law that ended the stretch IRA for most retirement account beneficiaries. Even though the law is named the “SECURE Act,” the true effect is the opposite.

The SECURE Act completely upended decades of established tax law that families relied on for passing their individual retirement accounts (IRAs) and other retirement accounts to their beneficiaries using the so-called “stretch IRA.” Most non-spouse beneficiaries will now have to withdraw their inherited retirement funds within 10 years after death. Bunching that income into a shorter time period will likely result in an overall higher tax bill.

What Is (or Was) the Stretch IRA?

The stretch IRA is a simple concept. It is the ability of the named beneficiary to spread (or stretch) required post-death distributions over the beneficiary’s life expectancy. This allowed beneficiaries to extend their required minimum distributions (RMDs) over decades in some cases, spreading the tax bill over all those years.

Designated Beneficiaries

Individuals named on the beneficiary form and qualifying see-through trusts are “designated beneficiaries.” Any designated beneficiary who inherited before 2020 still gets to continue the stretch IRA.

In addition, the SECURE Act created a new designated beneficiary category named “eligible designated beneficiary” (EDB). EDBs continue to get the stretch IRA.

Extended Effective Dates

The effective date for the elimination of the stretch IRA and the new 10-year rule generally applies to deaths after December 31, 2019. That effective date is extended for two years (for deaths after December 31, 2021) for governmental plans, including 403(b) and 457(b) plans, and the Thrift Savings Plan (TSP). It is also extended for as long as two years for collectively bargained plans, depending on the expiration date of the union contract.

Retirement Accounts Affected

The elimination of the stretch IRA and the new 10-year rule provisions apply to defined-contribution plans, including 401(k), 403(b) and 457(b) plans, and traditional and Roth IRAs. The new rule does not apply to defined-benefit plans (e.g., pensions).

Kinds of Retirement Plan Beneficiaries

Under the SECURE Act, there are now three kinds of retirement plan beneficiaries for determining post-death payouts after 2019:

1. Non-designated beneficiary (NDB)
2. Non-eligible designated beneficiary (NEDB)
3. Eligible designated beneficiary (EDB)

Eligible Designated Beneficiary: Stretch Still Applies

EDBs are a new category of beneficiaries created under the SECURE Act. The SECURE Act exempts these beneficiaries from the 10-year rule. EDBs must be designated beneficiaries (they still must be named on the retirement account beneficiary form).

• There are five classes of eligible designated beneficiaries:
• Surviving spouses;
• Minor children, up to majority age, or if still in school, up to age 26—but not grandchildren;
• Disabled individuals—under the strict IRS rules;
• Chronically ill individuals; and
• Individuals not more than 10 years younger than the IRA owner.

Plus, any designated beneficiary (including qualifying trusts) who inherited before 2020 is grandfathered under the pre-2020 stretch IRA rules. In addition, trusts for the sole benefit of these EDBs should qualify as an EDB.

EDBs are unaffected by the new rules. But once they no longer qualify as EDBs, or when they die, the 10-year rule is applied for them or for their beneficiaries.

How the 10-Year Rule Works

For most non-spouse beneficiaries, the ability to stretch RMDs from an inherited IRA will be replaced with a 10-year rule. There are no annual RMDs, but the entire inherited account balance must be emptied by the end of the 10th year after the IRA owner’s death. However, even though there is no longer a stretch IRA available for these beneficiaries, there is a tax planning benefit with the 10-year rule. During the 10-year period, there is flexibility, so payments during the 10 years can be taken according to what is best taxwise for each beneficiary. That can help beneficiaries plan out their withdrawals during the 10 years. The beneficiary may choose to take nothing during a particular year or take large distributions in others, as long as the account balance is emptied by the end of the 10-year term.

In the 10th year following the year of death, any funds remaining in the inherited IRA would then become the RMD. If these funds are not taken by the deadline, a 50% penalty would be owed.

Lifetime Beneficiary Planning

The beneficiary can be changed at any time during the lifetime of the IRA owner and, in some cases, even after death (through disclaimers or death of a beneficiary). Lifetime distributions do not depend on the existence or identity of the beneficiary except in limited cases. However, every retirement account should still have a designated beneficiary and a contingent beneficiary in place at all times. Failure to have a designated beneficiary in place at death could result in the loss of the extended payout, that is, the stretch IRA, for beneficiaries who will still qualify for the stretch IRA under the SECURE Act.

Failure to have a designated beneficiary can also result in the loss of the new 10-year post-death payout option for deaths in 2020 or later. In addition, the SECURE Act may require a new look at beneficiary planning.

Older Beneficiaries Can Use the Longest Life

Here is an unusual and not well-known rule that can benefit a beneficiary who is older than you, like a sibling, partner or friend. If the IRA owner dies after their required beginning date (i.e., the date RMDs must begin, which is now April 1 after their age 72 year) and the designated beneficiary is older than them, the beneficiary can use the deceased IRA owner’s remaining single life expectancy rather than the beneficiary’s life expectancy. This will give the beneficiary a longer life expectancy for distributions than they would have had if they had to use their own life expectancy.

New Stretch IRA and Beneficiary Payout Rules and Examples

Now that you have the basics down, use these simple examples to see how the beneficiary payout rules will work.

Designated Beneficiary Is Not a Surviving Spouse

Example 1: Non-EDB inherits in 2020

In 2020, Tom, age 32, inherits a Roth IRA from his father. He is a designated beneficiary, but he is not an eligible designated beneficiary. This means he is subject to the 10-year rule. Tom can take as much or as little as he desires out of the inherited Roth IRA each year during the 10-year period, but he must withdraw the entire Roth IRA by December 31, 2030, or he will be subject to the 50% penalty on the amount not taken.

Example 2: EDB inherits in 2020

In 2020, Lisa, age 10, inherits an IRA from her mother. Lisa is a minor child so she qualifies as an eligible designated beneficiary and can stretch distributions over her single life expectancy, based on the IRS Single Life Expectancy Table. This goes on for eight years. Lisa’s 18th birthday is in 2028 and she is no longer in school. Because Lisa has reached the age of majority, the 10-year rule now applies. This means that Lisa must empty the inherited IRA by December 31, 2038—by the end of the 10th year after she reached the age of majority (which in her state was age 18).

Surviving Spouse Is an Eligible Designated Beneficiary

Example 3: Spouse inherits in 2020

Jim and Joann are a married couple. Jim dies in 2020 at age 75 (after his required beginning distribution date) and leaves his IRA to Joann, age 57. Joann needs access to the funds, so she elects to treat it as an inherited IRA. She will have an RMD, but by choosing to handle the account as an inherited IRA, she will be allowed to take additional distributions while avoiding the 10% early withdrawal penalty.

As an EDB, Joann stretches the RMD payments over her single life expectancy, recalculated each year. At age 60, Joann does a spousal rollover of the inherited IRA and her inherited IRA RMDs stop. Joann dies two years later at age 62 and leaves the IRA to her son Jeffery, age 30. Jeffery is not an EDB, so the SECURE Act requires a 10-year term to pay out the IRA. Jeffery must deplete the account by the end of the 10th year following his mother’s death.

Temporary Stretch for Minor Children

A minor child of the IRA owner (but not a grandchild) who qualifies under the SECURE Act as an EDB can stretch IRA payments until the age of majority (age 18 in most states) or up to age 26 if still in school. At that point, the 10-year term payout will kick in.

Example 4: Two children inherit in 2020, one is a minor and one is not

Kristy dies on April 30, 2020, and leaves her IRA to her two daughters—Alexa, age 18, and Zoey, age 14. Since Alexa is of majority age and is no longer in school, she is bound by the 10-year payout rule. She will have no annual RMDs, but her inherited IRA will need to be emptied by the end of the 10th year after her mother’s death.

Zoey, on the other hand, is a minor. She can temporarily stretch the inherited IRA based on her single life expectancy (67.9 for a 15-year-old—her age in the year after her mother’s death and reducing that factor by one year for each year of the stretch). Zoey takes annual RMDs for eight years, until she finishes her education on her 22nd birthday in 2028. Zoey’s annual RMDs can then be stopped since the 10-year payout term springs forward. However, Zoey must empty the remaining account by the end of the 10th year after her 22nd birthday.

Payout for Chronically Ill or Disabled Beneficiaries (EDBs)

Those who are chronically ill or disabled as defined under the tax code on the date of the IRA owner’s death qualify as an eligible designated beneficiary and are permitted to stretch inherited RMD payments over their life expectancy.

Example 5: Chronically ill beneficiary inherits in 2020

Grandma Gertrude dies on July 4, 2020. She named her grandson Gary, age 30, as her primary beneficiary. On that date, Gary qualifies as “chronically ill” under the tax code definition. Since Grandma Gertrude died in 2020, the SECURE Act rules apply. Gary can stretch the RMD payments because he is an eligible designated beneficiary due to his medical condition.

Gary uses the Single Life Expectancy Table for inherited IRAs to determine his RMD factor (52.4 for a 31-year-old—his age in the year after Grandma Gertrude’s death and reducing that factor by one year for each year of the stretch). Gary is required to take an annual RMD until the account is depleted.

10-Year Rule for Those Not More Than 10 Years Younger Than the IRA Owner

A non-spouse beneficiary who is not more than 10 years younger than the deceased IRA owner is an EDB under the SECURE Act and can use their own age to stretch inherited IRA RMD payments.

Example 6: Sibling less than 10 years younger inherits in 2020

Three sisters are a tight group. Sandra is the eldest at 70, Sheri is 61 and Celeste is 59.

Sandra dies in 2020 and leaves an IRA to both of her younger sisters. Since Sheri (61) is less than 10 years younger than Sandra, she qualifies as an eligible designated beneficiary and can stretch RMD payments over her single life expectancy (23.5 for a 62-year-old, her age in the year after death and reducing that factor by one year for each year of the stretch).

Younger sister Celeste is only 59. She is more than 10 years younger than Sandra. Therefore, she is not considered an EDB and is bound by the 10-year payout term. Celeste’s inherited IRA must be emptied by the end of the 10th year following her older sister Sandra’s death. (Meanwhile, if she only takes the RMD, middle sister Sheri can continue to stretch her inherited IRA RMD payments for more than another decade beyond when younger sister Celeste had to empty her account.)

Date of Death Determines EDB Status

Example 7: Non-EDB inherits in 2020, but becomes disabled in a later year

John dies on August 1, 2020. He named his son Jerry, age 30, as his primary beneficiary. Jerry is bound by the SECURE Act, which dictates he must use the 10-year payout for the inherited IRA. Jerry gets into a car accident six months later. He is fully disabled under the tax code rules, but still cannot stretch the inherited IRA over his life expectancy. He cannot qualify as an EDB because he was not disabled as of the date of his father’s death.

Non-Designated Beneficiary Payout Rules

While much attention has been focused on the fate of designated beneficiaries under the SECURE Act and the fact that they will mostly be subject to a 10-year

payout rule, there has not been as much attention paid to non-designated beneficiaries. The SECURE Act leaves the rules for non-designated beneficiaries (e.g., estate as the beneficiary, non-qualifying trust, charity) completely unchanged. These rules are generally less favorable, which again is why you should always have a designated beneficiary—an individual named on the retirement account beneficiary form. See the SECURE Act Beneficiary Payout box on page 8.

Successor Beneficiary Payout Rules

The successor beneficiary is the original beneficiary’s beneficiary. Successor beneficiaries of owners who die after 2019 are also subject to the 10-year payout rule—even if the first beneficiary was considered an eligible designated beneficiary and could use the stretch rule.

Example 8: IRA owner dies in 2019, and beneficiary dies in 2020

Ann dies on November 1, 2019. She named her daughter Bea, age 48 on the day of Ann’s death, as her primary beneficiary. Even though Bea is not an eligible designated beneficiary under the SECURE Act, she gets to take advantage of the stretch rules because Ann died in 2019. Bea dies on January 1, 2020, with her grandchild CeCe as beneficiary. CeCe must receive the remaining IRA by the end of the 10th year following Bea’s death (December 31, 2030) because Cece is a successor beneficiary.

Example 9: Chronically ill beneficiary inherits in 2020, and then dies in 2028

Grandma Gertrude dies on July 4, 2020. She named her grandson Gary, age 30, as her primary beneficiary. On that date, Gary qualifies as “chronically ill” under the tax code definition, so he can begin taking stretch RMDs. Gary dies in 2028 with his minor child Jay designated as the primary beneficiary. Jay must receive the remaining IRA portion by the end of the 10th year following his father’s death because he is a successor beneficiary.

SECURE Act Rules for a Trust for Disabled or Chronically Ill Beneficiaries

While the SECURE Act will limit most non-spouse beneficiaries to a 10-year payout, there are special rules for trusts set up for disabled or chronically ill beneficiaries that allow RMDs to be paid from the IRA to the trust using the beneficiary’s life expectancy, per the IRS Single Life Expectancy Table.

Conclusion

Based on these new RMD rules, which are already in effect, you should review your current estate plan for your retirement accounts and inform your beneficiaries how their post-death payouts will work.

Most important though, update your beneficiary forms for all your retirement accounts. That will be your estate plan for these funds. 

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