Mark Twain famously said, “Those that respect the law and love sausage should watch neither being made.”
It could be said that goes doubly for Federal Regulations. It was in 2002 that final Treasury Regulations were first issued to govern IRA/401(k) distributions under the Internal Revenue Code of 1986, then The Secure Act was passed in 2020, followed by proposed regulations in early 2022, and Secure Act 2.0 later that same year.
At long last, to consolidate and update all of the above, final Treasury Regulations (along with a few more proposed regulations) were issued in July 2024. These regulations extend for over 250 pages, and our Firm has been immersed in their study so as to advise our clients of their best options going forward.
To be sure, The Secure Act is a transformational tax law in terms of post-death income tax on inherited IRAs.
To provide context, the Investment Company Institute estimates there is approximately $8 trillion in 401(k) assets and $14 trillion in IRA assets, as of the beginning of 2024. So it is not really a surprise that Congress would seize on an opportunity to tax these assets sooner rather than later, as the population ages and the impending generational transfer of this wealth looms large.
This is the main thrust of The Secure Act and its regulations. Under the new rules, seniors can leave funds in their qualified retirement plans longer, affording somewhat greater income tax deferral. However, their heirs will encounter quite a compressed time frame for withdrawal of the funds and recognition of the income tax on what they inherit from an IRA or 401(k).
During lifetime of senior owners
▸ The old law required the IRA owner, or 401(k) participant (the owner), to start required minimum distributions (RMDs) by reference to attaining age 70 ½. Distributions are required by April 1 following the year the owner reaches such age (called the required beginning date). The following shows the new rules for beginning required distributions, depending on the owner’s date of birth:
DOB from 7/1/49 to 12/31/50 Age 72
DOB from 1/1/51 to 12/31/59 Age 73
DOB from 1/1/60 forward Age 75
▸ The favorable spousal IRA rollover rules were left essentially unaltered, providing the owner’s spouse with handsome deferral opportunities if named as the beneficiary of these accounts.
After death of senior owners
▸ For owners dying after 2019, their designated beneficiaries will be required to liquidate the entire IRA by the end of the 10th year following death. For example, if husband dies and passes his IRA to wife and then she dies and passes it to their children (or qualifying trusts for their children), at the wife’s death, the 10-year compressed withdrawal/taxation period starts.
▸ Some beneficiaries are exempt from the compressed 10-year rule, those being spouses, disabled beneficiaries, chronically ill beneficiaries and minors (with the 10-year compressed period merely postponed until adulthood).
▸ Due to misleading instructions in the previous version of IRS Publication 590-B, taxpayers and their advisers assumed no distributions were required within the 10-year period, even if the owner died after his required beginning date. Recognizing the inequity of this, IRS issued a series of formal Notices, relieving such beneficiaries from taking RMDs for years 2021-2024. The regulations now make it clear these distributions are not simply deferred but fully waived. As such, RMDs resume in 2025 for these beneficiaries, with the remaining 10-year period to be applied to the balance in the IRA. As an example, if Parent died at age 80 in 2022 with children A & B as his IRA beneficiaries, they are relieved of taking RMDs in 2023 and 2024. A & B must withdraw (at least) their RMDs for 2025 through 2031 (based on their own life expectancy) and fully liquidate their inherited IRA by the end of 2032. Fortunately, no such distributions are required from Roth IRAs until year 10, even if the owner died after his required beginning date.
And finally, the Farner & Perrin way forward:
A majority of our clients want trusts in their estate plans, and they do not see the IRA/40l(k) assets any differently. Reasons range from creditor and divorce protection for their children, to the avoidance of transfer tax at the children’s deaths, to protecting the children of the first to die in the case of a blended family.
Trusts can still be used for your IRA/40l(k) planning, but special drafting is recommended to incorporate this new law and its regulations. To assure the availability of the 10-year period, you may need to revise your trusts (including those established under your Will). At the same time, we can help you incorporate ways to address the high income tax rate applied to trusts.
Especially if your estate plan was done before 2020, it is important to review and reconsider how the new law and regulations affect your estate plan. Give us a call to determine what changes you may wish to make to your particular plan.