May 18, 2021

The Secure Act: Elimination of the Stretch Option for Certain Beneficiaries of Inherited Retirement Assets

Micah G. Snitzer

The Setting Every Community Up for Retirement Enhancement Act (the “SECURE Act”) took effect January 1, 2020, revising federal rules that govern the administration of qualified retirement plans (e.g., 401(k) and 403(b) plans) and IRAs.  Among the changes effected by the new law is the shrinking of the class of beneficiaries who can stretch out their required minimum distributions (RMDs) from such accounts over their expected lifetime.  This stretch of RMDs was a tax benefit, because it allowed the beneficiary to defer income tax, keeping assets in the tax-favored vehicle as long as possible, where they could grow without diminishment; it is only upon distribution that the assets would be subject to income tax.

The SECURE Act imposes a maximum 10-year payout rule for retirement accounts inherited from someone dying in 2020 or later, unless the named beneficiary (i) is the surviving spouse of the deceased owner, (ii) is disabled (iii) is chronically ill, (iv) is not more than 10 years younger than the deceased owner, or (v) is a minor child of the deceased owner.  In the case of a minor child or a trust for the benefit of a minor child, the 10-year payout rule does apply, but that clock does not begin to tick until the child reaches the age of majority.

A beneficiary subject to the 10-year payout rule has some flexibility in timing distributions.  In contrast to a beneficiary utilizing the lifetime stretch, who will have to take an annual RMD, a beneficiary subject to the 10-year payout rule is not required to take an annual RMD over the 10-year period.  Instead, the beneficiary may wait until the last day of the 10-year payout period to take any distribution at all, as long as the entire inherited account is distributed to the beneficiary by the end of the tenth year after the death of the owner.

The lifetime stretch option for RMDs, more broadly available under prior law, is now available only to the surviving spouse of the deceased owner or to a beneficiary who is disabled, chronically ill, or not more than 10 years younger than the deceased owner.  Except for trust beneficiaries falling into this preferred class, the inclusion of special language in a trust’s governing instrument no longer facilitates the RMD lifetime stretch-out for retirement accounts payable to a trust.

Should you panic?  No.

Although many notices and alerts in our industry call for everyone to rethink their retirement account beneficiary designations and the language of their estate planning documents, for most clients the SECURE Act does not require any revision to their estate planning documents to achieve or preserve the best available tax efficiency.

Many IRA owners name their spouse, individually, or a charitable institution as beneficiary of retirement assets; no change to these arrangements is necessitated by the SECURE Act.

Often IRA owners name a child or grandchild, individually, as beneficiary; in most cases, the beneficiary will no longer be able to stretch the RMDs over his or her expected lifetime.  However, unless that fact prompts the account owner to want to change his/her beneficiaries altogether, s/he need not revise anything in reaction to this law change, either.

Some IRA owners name a trust for an individual as beneficiary of a retirement account.  Often such a trust will have been drafted with special (“conduit”) language in order to qualify, under the old rules, for the RMD stretch-out based upon the life expectancy of the individual trust beneficiary.  The downside is that a conduit trust requires all amounts distributed to the trust from a retirement account be, in turn, distributed from the trust to the individual trust beneficiary.  That downside of the special conduit language was tolerated by IRA owners under the old rules because of the ability to stretch out the RMDs over the expected lifetime of the individual trust beneficiary.  However, now that not every individual who is the beneficiary of a trust is eligible to stretch out the RMDs over the beneficiary’s life expectancy (e.g., an adult child who is not disabled or chronically ill), some IRA owners may prefer to have the trust accumulate amounts from retirement accounts, retaining them in the trustee’s hands rather than distributing them out to the individual beneficiary.  These clients may wish to consult their estate planning attorney to discuss revising the trust. The SECURE Act may make a Roth conversion or obtaining additional life insurance more appealing to certain clients, or it may prompt some to direct more retirement assets to charity.  At your next periodic review with your estate planner you may wish to explore whether these options make sense for your plan.