SECURE ACT 1.0 and SECURE ACT 2.0

Under the original SECURE Act, a designated beneficiary is an individual (or a qualifying “see through” trust) named by the deceased account owner that is not in (or for the benefit of) one of five categories of eligible designated beneficiaries - (1) the account owner’s spouse, or (2) a minor child (not grandchild) of the account owner, or (3) disabled individual, or (4) chronically ill individual or (5) an individual who is not more than 10 years younger than then deceased account owner.   Only eligible designated beneficiaries in one of these five categories may “stretch” distributions from an inherited account over their life expectancy.  The original SECURE Act eliminated stretch distributions for designated beneficiaries. Designated beneficiaries like the adult children of a parent who was already receiving RMDs before they died must follow a 10 year distribution rule if they inherited a retirement account after January 1, 2020.  (Note that designated beneficiaries who inherit a retirement account before January 1, 2020, can still receive distributions based on their life expectancy.)  
 

In February 2022, the Internal Revenue Service (IRS) issued proposed regulations for the 10 year rule. Under the proposed regulations, if you are the designated beneficiary of an account owner who died after January 1, 2020, and who was receiving RMDs, you must:  (1) take RMDS based on your life expectancy in years one through nine; and (2) withdraw the entire balance by the end of the tenth year that follows the year of the original account owner’s death. 
 

The first requirement, i.e. RMDs in years one through nine was a surprise.  Prior to the proposed regulation, most certified professional accountants and tax attorneys thought that the original SECURE Act did not require designated beneficiaries to take a distribution until year 10.   Given that the proposed regulation was issued two years after the original SECURE Act became effective, there was concern that designated beneficiaries would be assessed a penalty for RMDs that they did not know they had to take.  Fortunately, in October 2022, the IRS issued notice 2022-53 in which it waived the penalty for designated beneficiaries who did not take an RMD in either 2021 or 2022.  
 

So what does this mean for designated beneficiaries in 2023?  Although the regulation’s status is still “proposed” and the IRS has not deemed it to be final, designated beneficiaries of traditional IRAs should meet with their income tax professional and for a plan for the distributions.  
 

Distributions from a traditional IRA are taxed as ordinary income.  If you’ve inherited a traditional IRA with a substantial balance, RMDs in years one through nine may not be sufficient to avoid a big income tax bill from the final distribution in year 10.  Meeting with your tax professional can help you mitigate the income tax consequences of the 10 year rule.  For example, you can distribute more than the RMD in years one through nine and match it with deductions like charitable gifts to offset your taxable income.  Or, if you expect your income to be lower in a certain year, you could increase your withdrawal without moving into a higher tax bracket.   

The original SECURE Act and 2.0 changed the age when account owners must begin RMDs from their retirement accounts. Before the original SECURE Act, account owners had to begin their RMDs at age 70 ½. The original SECURE Act increased the mandatory distribution age to 72 for account owners who turned 70 ½ after its effective date of January 1, 2020.  Now, under 2.0, if you were born in 1951 through 1959, your RMD age is delayed to 73.  If you were born in 1960 or later, 2.0 delayed your RMD age to 75.   

If you turn age 72 this year, you do not have to start your RMDs until next year when you reach age 73. What if you are only age 65 or an even younger age 60? Your planning opportunities allow you to connect Medicare, Social Security and RMDs. You are eligible for Medicare at age 65, and depending on your birth date, your full Social Security full retirement age will be 66 or 66 plus a period of months or age 67.  You can start Social Security later than your full retirement age to increase your benefit, but you won’t receive delayed claim credits after age 70.  Think about how access to Medicare could allow you to step back to part time employment or whether Social Security plus investment income can support your cash flow before age 73 or age 75.  Cape Cod 5 can help you review these details and make choices that fit your goals and lifestyle.   

A QCD is a distribution from an IRA directly to tax exempt 501(c)(3) charity. QCDs are often used to fulfill the account owner’s charitable intent and reduce their modified adjusted gross income. Under both the original SECURE Act and 2.0, an account owner may start to make QCDs at age 70 ½. 

• Employers with less than 100 employees may offer a Saving Incentive Match Plan AKA SIMPLE IRA for their employees. Smaller employers may also offer employees a different type of IRA known as a Simplified Employee Pension Plan or SEP IRA. Employees can contribute to SIMPLE IRAs, but only employers can contribution to SEP IRAs.  Prior to 2.0, neither SIMPLE IRAs nor SEP IRAs could offer a Roth contribution option. Although this change under 2.0 is available now, employers must implement the option before employees can begin Roth contributions to a SIMPLE IRA or SEP IRA.  
   

• Roth contributions are post tax which means that you pay income tax on the amount contributed, but the contributions grow tax free and are not taxable income when withdrawn. The Roth IRAs have an important and distinct advantage – account owners do not have to take RMDs during their lifetimes. Compare those advantages to the rules for traditional IRAs.  Contributions to a traditional IRA are pretax. The pretax contribution reduces your taxable income in that year, but withdrawals are taxable income and the account owner must take RMDs.   
   

• The advantages of Roth accounts link back to the 10 year distribution rule for designated beneficiaries.  The original SECURE Act’s 10 year distribution rule applies to designated beneficiaries of Roth accounts, but in a different way.  Designated beneficiaries of a Roth IRA do not have to take RMDs in years one through nine, but they must withdraw the entire balance by the end of the tenth year following the year of the account owner’s death.  This means that designated beneficiaries can let the inherited Roth IRA grow for 10 years before they are required to take the full distribution.  Also, if the account owner began Roth contributions to a SIMPLE or SEP IRA at least five years before dying, the contributions and their earnings will be distributed tax free to designated beneficiaries. (Remember that Roth accounts have different income tax rules for conversions and earnings on conversions. Cape Cod 5 can help you understand the income tax differences for Roth IRA contributions and conversions as part of your financial plan.) 

Yes. Starting in 2016, the Defending Public Safety Employees’ Retirement Act first allowed public safety workers to begin distributions as early as age 50 without incurring a 10% penalty.  Generally, there is a 10% penalty added to distributions take before age 59 ½. 2.0 created several new exceptions. 
 

Beginning in 2023, private sector firefighters, state and local corrections officers and employees with 25 or more years of service with the same employer may begin distributions at age 50 from an employer’s plan without incurring a 10% penalty.  Be sure not to confuse penalty-free with income taxes.  A penalty may not be assessed on the withdrawal, but it will still be taxable income.