Before the Secure Act, an IRA beneficiary could use the Life Expectancy Rule. Under the Life Expectancy Rule, he an IRA beneficiary could keep his inherited IRA invested for his lifetime subject to Required Minimum Distributions (RMD). Every year, the beneficiary would have to take a RMD based on his life expectancy. The younger the beneficiary, the less the distribution. The distribution would be taxable as income. But the balance of the inherited IRA could grow tax free. The investment strategy would be to distribute as little as possible so the IRA could grow tax free. This was a great deal.
The Secure Act changes this. Now the beneficiary must distribute all of the IRA within ten years. There are no Required Minimum Distributions. The beneficiary can choose when to take distributions, but the IRA must all be distributed within ten years. Tax-free growth now ends within ten years – but not in all cases.
The Secure Act carves out exceptions to the Ten-Year Rule. These exceptions are called Eligible Designated Beneficiaries. Eligible Designated Beneficiaries can use the Life Expectancy Rule and keep their inherited IRA growing tax free beyond ten years, subject to Required Minimum Distributions.
The Eligible Designated Beneficiaries are:
- Surviving Spouse
- Children “under the age of majority”
- Chronically ill
- A person not more than ten years younger than the Employee
Surviving Spouse. The Secure Act did not change the surviving spouse’s options to roll-over the deceased spouse’s IRA and make it her own or to make it an inherited IRA subject to RMD under the old Life Expectancy Rule.
Children of the Employee Under the Age of Majority. There are two requirements for this exception. First, the child beneficiary must be a child of the retirement plan owner, and second, the child must not have reached the age of majority. If both requirements are met, the child beneficiary can use the Life Expectancy Rule until she hits the age of majority. But once at the age of majority, she is no longer considered an Eligible Designated Beneficiary, and she will have to use the Ten-Year Rule.
The Secure Act age does not clearly define age of majority. Most say it is age 18, or in some states, age 21. Some say it could be up to age 26 if the child has not completed a specified course of education. This should be sorted out in upcoming regulations.
Disabled. A disabled person is defined as: “someone unable to engage in any substantial gainful activity by reason of any medical determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration.” The disabled person will have to show proof of the disability. If shown to be disabled, the beneficiary can use the Life Expectancy Rule.
Chronically Ill. A chronically ill person is someone who has been certified by a licensed health care practitioner as:
- Unable to do at least two activities of daily living for at least 90 days because of loss of functional capacity; or
- Requiring supervision to protect themselves from health and safety threats.
If chronically ill, the beneficiary can use the Life Expectancy Rule.
Person Not More Than Ten Years Younger Than the Employee. A beneficiary who is no more than ten years younger than the employee can use the Life Expectancy Rule.
The Secure Act carve outs to the Ten Year Rule for Eligible Designated Beneficiaries can be very significant for those who qualify.