What You Need to Know: The Secure Act and Inherited IRAs

Author: Patricia Hall, CFP ®, Managing Director, Wealth Strategist

Traditional IRAs allow individuals to make annual contributions on a pre-tax or after-tax basis, subject to certain limitations.  The balances grow on a tax-free basis and are generally taxable when distributions are required to begin at the age of 72 based upon life expectancy factors issued by the IRS.  Roth IRAs allow individuals to make contributions on an after-tax basis, and if certain rules are met, future distributions will be free of tax.  In addition, Roth IRAs do not require the IRA owner to take minimum distributions during their lifetime, although minimum distributions are required for beneficiaries inheriting Roth IRAs. 

In 2019, Congress passed the SECURE Act which increased the age at which minimum distributions from IRAs are required to begin from age 70.5 to age 72.  In order to pay for this extension of time in the required beginning date, they also required that most non-spouse beneficiaries inheriting an IRA after 12/31/19 take distributions over a period of ten years from the original owner’s death.  This was a significant change from previous law that allowed non-spouse beneficiaries of an IRA to stretch IRA distributions over their lifetimes rather than the lifetime of the original owner.  These stretch IRAs allowed families to pass down an IRA from one generation to the next while continuing to optimize income tax deferral for their descendants.

While the stretch IRA has been eliminated for most beneficiaries inheriting IRAs after 12/31/19, the ten-year rule does not apply to the following beneficiaries who are also called “eligible designated beneficiaries:”

1. Surviving Spouse;
2. IRA owner’s children, while minors;
3. Certain chronically ill or disabled individuals; and
4. An individual who is less than ten years younger than the IRA owner.

Given that individuals are only required to begin withdrawing minimum amounts from traditional IRAs at the age of 72, it is probable that sizeable IRA balances will remain upon their death.  These assets will be distributed according to the beneficiary designation they have chosen for the IRA.  While beneficiaries are most often listed as named individuals, you can also name a trust as the beneficiary of an IRA, if appropriate.  When a trust inherits an IRA, the IRA is maintained as a separate account, and it is an asset of the trust to be distributed according to the terms of the trust.  Some reasons for naming a trust as the beneficiary of an IRA rather than an individual include the following:

1. If a minor is the intended beneficiary, naming a trust as the beneficiary could protect the minor’s interest and distribute the IRA according to the owner’s wishes.
2. Trusts are often used in second marriages allowing the IRA owner to control the ultimate disposition of the IRA assets upon the second death, while allowing the spouse to benefit during their lifetime.
3. Trusts can be used to limit a beneficiary’s access to the funds when needed. While minimum distributions to the trust are still required by law, a properly structured trust could dictate the timing of distributions to the beneficiary.
4. Trusts can provide added creditor protection.

Certain trusts called “See-through trusts” allow an IRA to be distributed to a trust upon death of the IRA owner over a potentially longer period than can be accomplished with non See-through trusts.  To qualify as a See-through trust, a trust must meet the following requirements:

1. It must be valid under state law;
2. It must be irrevocable or become irrevocable at death;
3. The trust beneficiaries must be identifiable; and
4. The IRA custodian must have copy of trust document within a certain time frame after death.

There are generally two types of See-through trusts receiving IRA distributions: Conduit Trusts and Accumulation Trusts.  The rules for distributions from these types of trusts are noted below:

Conduit Trusts:  Must pay out all distributions received from the IRA, including required minimum distributions, directly to the trust beneficiaries immediately upon receipt.  These trusts allow eligible designated beneficiaries to continue to receive distributions over their life expectancy.  Non-eligible designated beneficiaries, however, must receive distributions equally over a period of ten years. 

Accumulation Trusts:  These trusts allow for the accumulation of IRA distributions within the trust.  While these trusts must receive distributions equally over ten years, the ultimate distributions to the beneficiaries will be determined based upon the terms of the trust, allowing the trustee discretion in making distributions to the intended beneficiaries.

Non See-through trusts must be distributed within five years of 12/31 of the calendar year of the IRA owner’s death if they died prior to the age of 72.  If the IRA owner died after the age of 72, these trusts will distribute based upon the actuarial life expectancy of the IRA owner.

Beneficiary designations are an extremely important component of retirement planning to ensure IRA assets are distributed as intended.  While the above broadly summarizes the rules for beneficiaries inheriting IRAs, these rules are very complex and should be reviewed with your Beacon Trust team and/or estate planning attorney.

SECURITIES AND INVESTMENT PRODUCTS: NOT FDIC INSURED - MAY GO DOWN IN VALUE – NOT GUARANTEED BY A BANK OR BANK AFFILIATE - NOT A DEPOSIT - NOT INSURED BY ANY GOVERNMENT AGENCY