The rules governing retirement account distributions have undergone substantial changes since the enactment of the SECURE Act in 2019. This legislation altered how most non-spouse beneficiaries, called designated beneficiaries, handle after-death distributions of qualified retirement accounts.
Before the SECURE Act, these beneficiaries could stretch distributions over their life expectancy, spreading out the tax liability over many years. However, the SECURE Act introduced the 10-year rule, stating that the entire interest of the deceased employee’s account must be distributed to the designated beneficiaries within 10 years of the employee’s death.
The change created numerous implications for estate planning. This year, the IRS made a further change (discussed in further detail below), making it a good idea to review how it may impact your estate plan.
Changes Introduced by the SECURE Act of 2019
Under the SECURE Act, the concept of stretching distributions over a beneficiary’s life expectancy was limited. As a result, most non-spouse beneficiaries must withdraw the whole balance of the retirement account they have inherited within a decade. This change caused implications for estate planning, as it accelerates the timeline in which beneficiaries must recognize income and pay taxes on these distributions.
The SECURE Act does offer exceptions. Certain beneficiaries, classified as “eligible designated beneficiaries,” can still use the life expectancy rule — often referred to as the “stretch IRA” — for distributions. Eligible designated beneficiaries include surviving spouses, minor children of the deceased account holder (until they reach the age of majority), disabled or chronically ill individuals, and beneficiaries who are not more than 10 years younger than the decedent.
Required Minimum Distributions (RMDs) and the 2022 Proposed Regulations
The 2022 proposed regulations regarding required minimum distributions (RMDs) further clarified the implementation of the 10-year rule. These regulations specify that if the account holder dies on or after their required beginning date (the date by which they must start taking RMDs, which depends on when they turned 72), designated beneficiaries must take annual RMDs throughout the 10-year period. This rule prevents beneficiaries from delaying distributions until the final year of the 10-year period, which could result in a large, taxable lump-sum distribution.
IRS Notices and Temporary Relief
Recognizing the challenges posed by these changes, the IRS has released several notices to provide temporary relief to beneficiaries faced with the new requirements. On April 16, 2024, the IRS released Notice 2024-35. The most recent notice extended temporary relief to those who fail to take RMDs for 2024 by waiving the steep excise tax imposed on beneficiaries that is mandated by the SECURE Act’s 10-year rule. It builds on previous notices, specifically Notices 2022-53 and 2023-54, which waived the excise taxes for beneficiaries who did not take RMDs for 2021, 2022, and 2023.
The excise tax in question is hefty; it was set at 50% of the RMD amount not withdrawn but was reduced to 25%, with the option to reduce the penalty even further to 10% if the RMD is corrected in a timely manner. The IRS’s decision to waive this penalty thus provides substantial relief to beneficiaries who may have had difficulty complying with the new rules due to a lack of understanding or other administrative challenges.
Future Regulations and Compliance
Notice 2024-35 also suggested that the IRS intends to issue final regulations on RMDs that will apply to distributions for calendar years beginning on or after January 1, 2025. The hope is that these future regulations will clarify further how to apply the SECURE Act’s rules, aiding beneficiaries in understanding and, as a result, upholding their obligations.
Implications for Estate Planning
The IRS’s extension of relief has numerous implications for estate planning. However, while the temporary excise tax waiver aims to alleviate some immediate financial burdens for beneficiaries, the basic requirements stipulated by the Act are unchanged.
That means the entire account balance must be distributed within 10 years of the account holder’s death. This accelerated distribution schedule necessitates careful planning by an Alabama estate planning attorney working alongside financial professionals to manage the potential tax implications.
Considerations for Beneficiaries
While the relief waives penalties for missed RMDs, beneficiaries should still plan to strategize. Specifically, they must examine and manage the timing of distributions to avoid tax increases during the last year of the 10-year period.
Annual required minimum distributions (RMDs) spread the tax liability, keeping the beneficiary in a lower tax bracket each year. This approach helps manage the tax burden, avoiding a large lump-sum distribution that could occur if all funds are withdrawn at once at the end of the 10-year period.
Although the IRS has temporarily waived the excise tax for missed RMDs during the relief period, beneficiaries should still comply with the overall distribution requirements. Temporary relief from penalties does not obviate the need to distribute the entire account balance within the 10-year timeframe. Beneficiaries should, therefore, consider working with an Alabama estate planning attorney and the attorney’s financial advisors to create a distribution strategy that matches their financial goals while minimizing their tax liability.
Consult an Alabama estate planning attorney for guidance about changes to the SECURE Act of 2019 affecting IRA beneficiaries.
The relief the IRS is providing offers a valuable opportunity to reassess estate planning strategies and adjust to the new regulatory landscape. As the IRS works toward finalizing regulations for RMDs, beneficiaries like yourself, with the guidance of an Alabama estate planning attorney and a financial advisor on their team, should stay on top of the evolving rules so your distribution strategies continue to comply with the new requirements. By doing so, you can mitigate any potential tax liabilities and make informed decisions that support your long-term financial objectives.
The same holds if you are first creating an estate plan or examining the implications of your current plan, given the new changes to the current rules. At Summit Family Law, we stay abreast of changes in tax laws to help our clients achieve their estate planning goals. We understand well how paying taxes can cause apprehension in many people, especially when already convoluted tax laws change, making them even more difficult to navigate than they are typically.
If you are unclear about how changes to the SECURE Act of 2019 affecting beneficiaries might impact you, we can help. Call us at either our Huntsville or Birmingham locations today.
