The 10-Year Rule | Surprise Surprise
In late March, the IRS released its tax rules on withdrawals from individual retirement accounts. Normally, this is a routine process with no major surprises, but not this time. In this new 2021 version, updated on March 25, the IRS included an explanation of how the SECURE Act rules would work for post-death distributions from IRAs. One of the big changes in the SECURE Act was the elimination of the stretch IRA for most non-spouse beneficiaries. It was replaced with the “10-year rule,” which specifies that the inherited IRA (or Roth IRA) funds must be withdrawn by the end of the 10-year period after the death of the IRA owner. This 10-year rule applies to non-spouse designated beneficiaries (individuals like children and grandchildren).
Eligible designated beneficiaries, or EDBs, are exempt and can still use the stretch IRA as before: This group includes the spouse, certain minor children of the deceased IRA owner or plan participant, the disabled and chronically ill, and beneficiaries who are not more than 10 years younger than the deceased IRA owner. We believed that the 10-year rule meant that the inherited account would have to be emptied by the end of the 10-year period after death. Furthermore, no distributions would be required in years one through nine. There would only be one required minimum distribution, and that would be the balance of the inherited account at the end of the 10 years.
This was music to our ears. It would provide planning flexibility in years one to nine, allowing distributions to be adjusted to tax brackets in those years. This was also a benefit for inherited Roth IRAs, where nothing would have to be withdrawn from the inherited Roth IRA until the end of the 10th year after the death, allowing 10 years of tax-free buildup before the Roth funds would have to be withdrawn.
But in a shocker, IRS Publication 590-B says otherwise. Pages 11 and 12 provide an explanation and an example showing that beneficiaries would be subject to RMDs each year (as under the pre-SECURE Act rules) for years one through nine, and then the balance must be withdrawn in year 10. No one saw that coming! This doesn’t go along with the SECURE Act rules and committee reports, which seemed to indicate that the new 10-year rule would work like the old pre-SECURE Act five-year rule, with no annual distributions required. The issue of looking up life expectancies of beneficiaries or worrying about which age or factor should be used to calculate the RMD would be gone, since the funds simply had to be withdrawn in full by the end of the 10 years. If this is truly the way the post-death 10-year rule works, then some beneficiaries who inherited assets in 2020 will already be subject to 2021 RMDs that will need to be calculated.
A small beacon of hope is that the IRS has not yet released its official regulation on this matter. In addition, there will be a comment period, during which time things could all change. In other words — stay tuned. We have not heard the last on this one yet.