IRA beneficiary options: IRS surprises with 10-year rule guidance

Background

When the Internal Revenue Service (IRS) earlier this year posted (and then re-posted) its 2020 version of IRS Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs), it included surprising guidance as it relates to the SECURE Act’s 10-year rule, an option for certain designated beneficiaries who inherit an IRA in 2020 or later.

Eligible designated beneficiary – IRA owner died on or after his/her RBD

Before the IRS posted its 2020 versions of Publication 590-B, the general consensus in the retirement plan industry was that an eligible designated beneficiary (EDB) could elect to use either the ten-year rule or the single life expectancy method to distribute inherited IRA assets, without regard to the age at which the IRA owner dies. However, the IRS’s guidance provides that when an IRA owner dies on or after his/her required beginning date (RBD), an EDB can use only the single life expectancy method. Of course, an EDB who is the spouse of the deceased IRA owner can still elect to treat the inherited IRA as his/her own regardless of when the IRA owner’s death occurs – an option that did not change as a result of the SECURE Act. But the significant impact is that when an IRA owner’s death occurs on or after his/her RBD, an EDB cannot use the ten-year rule.

Example – Eligible designated beneficiary is a spouse

Mark, age 73, died in 2020 after his RBD. Mark’s spouse, Janet, age 56, is the beneficiary of his traditional IRA. Janet may elect to either treat Mark’s IRA as her own or continue to act in the capacity of a beneficiary and take death distributions using the single life expectancy method. If Janet elects the single life expectancy option, she would be required to take distributions annually. These distributions would be death distributions and are not subject to the 10 percent penalty tax. Janet retains the option to treat the inherited IRA as her own IRA at any point in the future. If Janet subsequently treats the IRA as her own IRA, she would be able to take normal distributions, at her discretion, upon attaining age 59½ and mandatory distributions upon attainment of age 72.

Example – Eligible designated beneficiary is a nonspouse

Andy, age 75, died in 2021 after his RBD. Andy’s brother, John, age 78, is the beneficiary of his traditional IRA. John must use the single life expectancy method to take annual death distributions.

Eligible designated beneficiary is a minor child of the IRA owner

For an IRA owner’s minor child that is receiving life expectancy payments, the IRS’s guidance provided in Publication 590-B indicates that the 10-year rule applies upon the minor child’s attainment of the age of majority and the 10-year period ends on the 10^th anniversary of attainment of age of majority. After the child attains the age of majority, he/she may take any distribution amount desired during the 10-year period. To avoid a 50 percent excess accumulation penalty tax, all IRA assets must be distributed by the end of year that contains the 10^th anniversary of attainment of the age of majority.

Example – Eligible designated beneficiary is a minor child of the IRA owner

Brad, age 43, died in 2020. His traditional IRA beneficiary is his son, Justin, age 14 in 2020. Justin takes life expectancy distributions beginning in 2021 through the age of majority, then has the 10-year rule. Assuming Justin’s age of majority is age 18, his 10-year period begins on the date of his attainment of the age of majority in 2024, and the entire IRA must be distributed by December 31, 2034.

Conclusion

Keep in mind IRS Publication 590-B is not tax law, and the guidance within is subject to change. Currently, the guidance as stated in the 2020 version of IRS Publication 590-B is the best insight available into current Treasury/IRS views. We will know more once temporary regulations are issued. Until then, an individual who is an EDB and has already elected to use the 10-year rule should review his/her specific circumstances with his/her tax or legal professional and make any necessary election/documentation changes.