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Inherited IRA/Secure Act

Inherited IRA/Secure Act

If a participant/owner of an IRA designates an individual as a beneficiary, who is a non-spouse of the participant, then upon the participant’s death the individual beneficiary can make a tax-free transfer from the trustee of the deceased participant’s account to the trustee of an Inherited IRA account of the beneficiary. Unlike a beneficiary who is the spouse of the participant, the non-spouse beneficiary cannot treat the inherited IRA as his or her own IRA, the non-spouse beneficiary cannot make any contributions to the Inherited IRA, or roll over any amounts into or out of the Inherited IRA. The required minimum distribution (RMD) rule is that the non-spouse beneficiary cannot wait to take distributions until the age of 70 ½ but must begin taking RMD distributions the year after participant’s death based upon the beneficiary’s life expectancy not that of the deceased participant’s life expectancy. Therefore, if the non-spouse beneficiary is much younger than the participant the IRA fund is able be paid out over a longer period of time.

With respect to creditors in bankruptcy, retirement plans are exempt from attachment by creditors under the Bankruptcy Code.  However, in the 2014 case of Clark vs. Rameker 134 S.Ct. 2242 (2014), the United States Supreme Court decided that an Inherited IRA did not qualify as a Retirement Fund for purposes of the exemption under the United States Bankruptcy Code because they are distinct from retirement funds as the beneficiary cannot treat such fund as their own as discussed above.

The question that arises is whether the Clark case would affect non-bankruptcy creditor situations (divorces, lawsuits, or other creditors). Some states provide no exemptions for creditors for retirement plans, and some states allow exemptions for retirement plans, and in other states there is uncertainty on that issue. As a result, many commentators and financial advisors suggest that an inherited IRA could be creditor protected if an accumulation trust is named as beneficiary of the IRA.  In so doing, the trustees will be in charge of distributing income to the trust beneficiaries (if that occurs the taxes would be at the trust rate rather than the individual rate but the income would not be available for creditors). Generally a trust is a not a “designated beneficiary” of an IRA and as a result withdrawal needs to be made within five years from the year after death of the participant, unless the trust meets the criteria of a “see-through trust”. To meet such “see-through trust” designation the trust must be valid under state law, must be irrevocable, the beneficiary individual of the trust must be identifiable, and documents must be submitted to the plan administrator. If the criteria is met then the beneficiary of the trust becomes the “designated beneficiary” for RMD purposes and he or she will be taxed individually on IRA distributions received based on the life expectancy (if multiple beneficiaries the RMD will be based on the oldest beneficiary’s life expectancy).

The Secure Act which was signed into law on December 20, 2019, and effective for participants who died after 2019, makes changes to the RMD rules. Life expectancy is eliminated and in lieu of the life expectancy rule the new payout period must be completed within 10 years of the year after death (with a few exceptions). Thus for an individual beneficiary of a qualified trust as discussed above who becomes a “designated beneficiary” all funds of the inherited account need be distributed within the 10th anniversary from the year after the death of the participant. This could harm creditor protection situations.

The Secure Act also increases the age at which an individual who owns an IRA must begin taking required minimum distributions. Now instead of 70 ½ the age is 72. This applies to those owners of IRA accounts that will attain a 70 ½ on or after January 1, 2020.

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