When a website tells you that your payment is “secure,” do you ever get the temptation to hold on to your wallet a little tighter? In March of 2022, the House of Representatives passed the Secure Act 2.0 (Setting Every Community Up for Retirement Enhancement). If you read the provisions to try and make sense of what was being proposed but ended up confused, don’t feel bad. It’s confusing. But I’m here to help.
If you have an IRA, 401(k), 403(b), thrift savings plan, 457 plan, or a Roth IRA, you will be affected by the SECURE Act.One item that the SECURE Act eliminated was the Stretch IRA. In other words, it removed the ability for a non-spouse beneficiary to inherit an IRA and take out the Required Minimum Distributions (RMDs) based on their age. This previously allowed them to keep the bulk of that IRA for as long as they live. Now, if you inherit an IRA, the account must be paid out entirely within ten years. This new rule applies to those who inherit an IRA in 2020 or later. It seems simple, right? Except, there are exceptions to the 10-year rule.
The operative date for eliminating the Stretch IRA and applying the 10-year rule applies to deaths that occured after December 31, 2019. However, that effective date is extended for two years if the death occurred after December 31, 2021, for government plans, including specific 403(b) plans, 457 plans, and the Thrift Savings Plan. The 2-year extension also applies to collectively bargain plans, depending on the union contract’s expiration date. And that’s where we have seen people confused because they think it is only for deaths after December 31, 2021. But that rule only applies to government plans, not IRAs, Roth IRAs, and 401(k)s.
Due to the Secure Act, there are now three kinds of retirement plan beneficiaries for determining post-death payouts after 2019. There is a Non-Designated Beneficiary (NDB), a Non-Eligible Designated Beneficiary (NEDB), and an Eligible Designated Beneficiary (EDB). Determining how the money must be withdrawn from your IRA or 401(k) when it passes to you will be dependant on which type of beneficiary you are.
A Non-Designated Beneficiary isn’t an individual. Instead, it’s acharity, estate, or a non-qualifying trust (a trust that does not have a look-through provision within the trust). For example, if someone filling out their beneficiary form writes that they want their IRA to go to the estate of Ken Osiwala, they shouldn’t have any problems because the estate isn’t a person. The estate would be a NDB, and the money must be withdrawn from the IRA within five years. When I say within five years, the beneficiary doesn’t have to take out RMDs for five years to drain the account. It can be taken in one lump sum within those five years. And the consequence of not withdrawing the total amount within a 5-year window is a 50% excise tax.
There are five classes of Eligible Designated Beneficiaries:
- A surviving spouse
- A minor child of the account owner under the age of 21, but not grandchildren
- Disabled individuals under strict IRS rules
- Chronically ill individuals
- Individuals that are not more than ten years younger than the IRA owner
An Eligible Designated Beneficiary is exempt from the 10-year rule. However, if the account owner dies before the required beginning date, an Eligible Designated Beneficiary can elect the 10-year rule.
Designated beneficiaries who do not qualify as an Eligible Designated Beneficiary are Non-Eligible Designated Beneficiaries. The post-death payout rules for the NEDB depend on if the death occurs before or after the Required Beginning Date (RBD). If the owner dies before the RBD, there are no annual RMDs during that 10-year window. If somebody dies before April 15 of the year following the year that they turned 72, then the Non-Eligible Designated Beneficiary must continue to follow the 10-year rule. But, they don’t have any RMDs during that 10-year window. They can choose when to withdraw the money. However, all the funds must be drained out of the IRA 10 years after the death took place.
Unless you work in the financial industry, these new rules and acronyms may seem as chaotic as alphabet soup. The average American may not understand if or how these new provisions will apply to their situation. This is why the Advisors at Osiwala Financial Group begin to educate ourselves when we learn that new laws and rules are coming to affect your retirement. And don’t get me wrong, the SECURE Act 2.0 is difficult to interpret for anyone, which is why my Advisors study to learn the ins and outs of these laws. This allows them to avoid costly mistakes while guiding clients.. To find out if and how the SECURE Act may affect your inherited IRAs, click HERE to make an appointment with one of the Advisors at Osiwala Financial Group. We are happy to meet you by phone, in-office, or virtually.
