When the SECURE Act was signed into law in December 2019, it ushered in some of the most significant changes to the rules for retirement accounts in well over a decade. At the same time, however, the statutory language included a number of provisions that were either ill-defined or left open to substantial IRS interpretation. To fill this gap, the IRS issued Proposed Regulations on February 23, 2022, to reflect the changes to the Internal Revenue Code made by the SECURE Act. The Proposed Regulations are likely to be amended at least somewhat before they are finalized, but they do provide the best window into the IRS’s current thinking on a variety of issues.
For many individuals, the most significant change made by the SECURE Act was the introduction of the 10-Year Rule, under which most non-spouse beneficiaries are required to distribute the entirety of their inherited retirement accounts by the end of the tenth year after the decedent’s death. But while the general consensus among practitioners was that such Non-Eligible Designated Beneficiaries would be allowed to distribute the entire account as a lump sum at the end of the 10th year instead of taking annual distributions to empty the account, the new Proposed Regulations seek to implement a system that would require Non-Eligible Designated Beneficiaries inheriting from retirement account owners who died on or after their Required Beginning Date to comply with the 10-year distribution requirement in addition to taking annual RMDs during that period.
The Proposed Regulations also clarify who can be considered an Eligible Designated Beneficiary (and who are able to use the previous ‘stretch’ RMD rules rather than the 10-Year Rule), including the decedent’s minor children, considered minors until they reach their 21st birthday regardless of the age of majority defined by state laws. Which means that minors would use the ‘stretch’ RMD rules until their 21st birthday, and then be subject to the 10-year rule and potential continued RMDs (if the decedent had reached their Required Beginning Date).
Furthermore, the Proposed Regulations provide significant new guidance on trust beneficiaries of retirement accounts, proposing that much of the existing trust-as-a-retirement-account-beneficiary structure be left in place, including the requirements for a trust to qualify as a “See-Through Trust” and the concepts of Conduit and Discretionary Trusts. In addition to continuing to allow remainder beneficiaries of a Conduit Trust to be disregarded when determining the post-death payout schedule of a See-Through Trust named as the beneficiary of a retirement account, the Proposed Regulations also outline other new types of Discretionary Trust beneficiaries that can be disregarded, including secondary beneficiaries who can only inherit trust assets contingent on the death of another secondary beneficiary, and beneficiaries who can only receive distributions of retirement assets from a trust that are first required to be fully distributed to a minor trust beneficiary before the end of the year in which they reach age 31 (provided that they survive to that age).
In a departure from IRS historical norms, the Proposed Regulations would prevent a general power of appointment from causing a trust to fail to meet the See-Through Trust requirement that beneficiaries of a trust be identifiable (given that certain requirements are met). Additionally, in the event that a trust is modified via a method provided for under state law, any trust beneficiaries removed via such a process by September 30th of the year following the year of death will not be considered when determining the trust’s post-death payout schedule.
Ultimately, the key point is that the IRS’s recent Proposed Regulations provide important insight and clarity on several aspects of the SECURE Act, of particular relevance to certain Non-Eligible Designated Beneficiaries and those with trusts. And while the Proposed Regulations can still be amended before they are finalized, taxpayers (and their advisors) can start preparing themselves now for how their individual situations might be affected!