By James I. Moore, CFP

Whenever an IRA owner dies before the account is fully depleted, the IRA will pass to whoever the owner named as beneficiary of the account. And unless that beneficiary was the original IRA owner’s spouse, the IRA will become an Inherited IRA.

Oftentimes, the beneficiary of that Inherited IRA will spend down the entire account during his or her lifetime. But sometimes, the beneficiary will die while there is still money in the inherited account. In this case, the account will again pass to the listed beneficiary and it will become what we will call an “Inherited Inherited IRA”.

It is important to note that there are different Required Minimum Distribution (RMD) rules for each of these account categories (IRA, Inherited IRA, and “Inherited Inherited IRA”). And these rules just recently changed in 2019.

SECURE Act

In December of 2019, the Setting Every Community Up for Retirement Enhancement Act of 2019 (more commonly known as the SECURE Act) became law. The SECURE Act changed many of the rules governing retirement accounts, including those regarding Required Minimum Distributions (RMDs) from inherited accounts. Some of the most significant changes in that regard were the elimination of the “stretch” provision for many non-spouse beneficiaries as well as the creation of the 10-year rule for non-eligible beneficiaries.

In addition to the changes for those who inherit retirement accounts, the SECURE Act also made some changes that affect the next beneficiary level—those that have inherited an inherited IRA after the original inheritor has died.

New rules for “Inherited Inherited IRAs”

The person who inherits an inherited IRA after the initial inheritor dies is called a Successor Beneficiary. Before the SECURE Act, the Successor Beneficiary would be required to continue taking annual distributions based on the previous account owner’s life expectancy. So what are the new distribution requirements?

Well, it gets a little complicated. It depends on 1.) when the original IRA owner died, and 2.) if the inheritor of the original IRA was an “Eligible Designated Beneficiary” or a “Non-Eligible Designated Beneficiary”.

The Inherited IRA owner would be considered an “Eligible Designated Beneficiary” if they fit into one of the categories below:

·         spouse of the decedent

·         minor child of the decedent

·         not more than 10 years younger than the decedent

·         a disabled or chronically ill individual

If the Inherited IRA owner did not fit into one of the above categories, then they would be classified as a “Non-Eligible Designated Beneficiary”.

With those beneficiary types defined, there are three different scenarios for a Successor Beneficiary who is inheriting an Inherited IRA:

Scenario #1: Successor Beneficiary of a pre-SECURE Act Designated Beneficiary

If the original IRA owner died before 1/1/2020 (before the SECURE Act became effective), then the Successor Beneficiary will be subject to the 10-year rule. The Successor Beneficiary must withdraw the entire balance of the retirement account within 10 years after inheriting the account.

Scenario #2: Successor Beneficiary of a post-SECURE Act Eligible Designated Beneficiary

If the original IRA owner died on or after 1/1/2020, and the inheritor was an Eligible Designated Beneficiary, then distribution rules are the same as Scenario #1. The Successor Beneficiary will be subject to the 10-year rule and must withdraw the entire balance of the retirement account within 10 years after inheriting the account.

Scenario #3: Successor Beneficiary of a post-SECURE Act Non-Eligible Designated Beneficiary

If the original IRA owner died on or after 1/1/2020, and the inheritor was a Non-Eligible Designated Beneficiary, the Successor Beneficiary does not get their own 10-year timeframe to withdraw the account. Instead, they must continue on with the current 10-year timeframe already in place for the previous beneficiary. For example, if the previous beneficiary inherited the account 6 years prior (and therefore is 6 years into the 10-year timeframe), the Successor Beneficiary must withdraw the remaining balance within 4 years.

Planning Opportunities

The SECURE Act basically took away the opportunity for Successor Beneficiaries to “stretch” the retirement account distributions out over their lifetime. While this will be a negative outcome for some individuals, for others it could actually provide extra flexibility and create some interesting planning opportunities.

For example, the 10-year rule stipulates that the entire retirement account has to be withdrawn within 10 years. However, the account owner has flexibility with how to take those withdrawals. They could choose to take annual withdrawals of relatively equal amounts over ten years. Alternatively, they could take no withdrawals for 9 years, and then distribute the entire account balance in the 10th year. With good planning, the account holder could take advantage of this flexibility to take withdrawals in years when their taxable income will be lower, and avoid taking withdrawals when their taxable income will be higher. Doing this could help smooth out their income level to prevent them from entering a higher tax bracket.

If you have specific questions about how these new rules impact your own unique situation, our Fullerton financial advisory firm is happy to help. Please feel free visit our website at www.eclecticassociates.com to schedule a complimentary phone call or meeting with one of our fee–only financial advisors.