In December of 2019, the SECURE Act became law.  Part of this new law was a change to how beneficiaries of qualified accounts (such as IRAs, 401(k)’s) must withdraw assets from these accounts after the death of the account owner.  Prior to the SECURE Act, a beneficiary had to take a minimum required distribution (MRD) each year.  The amount of the MRD was based on the account beneficiary’s age.  The basic idea was that the MRD withdrawals permitted the beneficiary to remove the assets over the life expectancy of the beneficiary.  The MRD was a minimal amount that the beneficiary had to withdraw, the beneficiary was free to take more or all of the account balance at any time.

Withdrawals from qualified accounts are taxable.  The account owner never paid tax on the assets in the account, so when the owner or the beneficiary takes withdrawals from the account, tax is due.  Permitting the beneficiary to remove money from the account over his (or her) life expectancy deferred the payment of tax on the assets in the qualified account over a very long period of time.

For instance, assume that Mrs. Smith is seventy-five years old.  She has $1,000,000 in her IRA.  Each year, Mrs. Smith—the qualified account (IRA) owner—must remove an MRD that is based upon her life expectancy.  The MRD is a small fraction of the $1,000,000.  The MRD gives Mrs. Smith an amount of money that is expected to support her in her retirement years.  The government believes the benefit of providing Mrs. Smith with retirement income outweighs the government’s need for tax revenues, so the government defers its collection of taxes until Mrs. Smith withdraws money from her IRA and only requires her to take the MRD each year.

Prior to the SECURE Act, the beneficiaries of Mrs. Smith’s IRA also could remove money over their life expectancies.  Like Mrs. Smith, the beneficiaries could defer paying tax over the remainder of their life expectancies.  The government would defer the collection of tax on the assets until the beneficiaries withdrew money from the IRA.

Tax deferral is a tremendous benefit.  Not only do you defer paying tax to a later date, which is a benefit in and of itself, but the owner and beneficiary also receives the benefit of tax-deferred growth.  If the owner/beneficiary had to pay tax, that would diminish the amount of money that was invested in the account.  This would diminish the amount of growth in the account.  A three percent gain on $1,000,000 is a greater gain than a three percent gain on $950,000.

In the past twenty years, I have seen a tremendous decrease in the number of my clients who have defined benefit pension plans.  What I call “old-timey pension plans.”  A pension plan I received from a company that I probably worked for most of my life and that pays me a fixed amount of income every month from the date of my retirement until the date of my death.  In that same period of time, I have seen a tremendous increase in clients who rely upon qualified accounts for their retirement income.

With all this money in qualified accounts, the government if deferring more and more tax money.  If the government is waiting for the owner or beneficiary to withdraw the money before it is taxed and if most investment money is in qualified accounts, then there is a tremendous amount of tax deferral.

The federal government realized this and changed the taxation of qualified accounts as it relates to most beneficiaries.  After the SECURE Act—with the exception of certain beneficiaries, such as a spouse—the beneficiary must withdraw the money from the account within ten years of the account owner’s death. So, now, for example, Mrs. Smith dies and her adult children must remove the money from her IRA within ten years of her death.

Recently the IRS published a document that instructs taxpayers how the ten-year rule works.  According to the IRS, the beneficiary must remove his/her MRD for each of the first nine years, then the balance in the tenth year.  This defined pattern is a shock to most attorneys and accountants and is subject to change when the IRS publishes its final regulations, so we shall see where the final rules end up.