10-YEAR PERIOD: DIFFERENT RULES WITHIN

Some of the proposed SECURE Act regulations, released in February, are convoluted and unnecessary. We have made our opinions known. Fortunately, many of the confounding new rules – several of which we have written about – will be limited in their impact. However, a discovery could affect a larger percentage of IRA and 401(k) beneficiaries. Combining a few basic principles may lead to inherited IRA confusion, such as the different rules within the 10-year period. Does order + order = chaos?

Example:

Joe, age 75, has a traditional IRA (“IRA X”). Joe dies and leaves the IRA to his daughter Lucy. Lucy does NOT qualify to stretch payments as an eligible designated beneficiary (EDB) over her lifetime, so she must apply the 10-year rule. The entire IRA must be withdrawn by the end of the tenth year after the year of death. Additionally, Joe died after his required beginning date (“RBD” – April 1 of the year after he turned 72), so Lucy must also take the required minimum distributions (RMDs) in years 1 – 9 of the ten years.

The above is straightforward, orderly, and recognized as the proper interpretation of the proposed SECURE Act regulations. Now we add another common scenario that inadvertently dials up the complexity.

Joe also had a 401(k) and was actively employed until the day he died. Since the 401(k) plan adopted the “still-working exception” and Joe did not own more than 5% of the company, his RBD would not have been until April 1 of the year after he separated from service (had he lived). As such, Joe was not yet taking RMDs from the 401(k). Daughter Lucy was the beneficiary of the plan. Since Lucy is not an EDB, she must also apply the 10-year payout rule to the 401(k). However, since Joe died before his plan RBD, Lucy will NOT have RMDs in years 1 – 9 within the ten years.

Again, orderly.

But Lucy elects to roll the 401(k) assets into an inherited IRA (“IRA Z”), which is a common request. Lucy now has two inherited IRAs from the same decedent. While both inherited IRAs must abide by the same 10-year period, assuming the beneficiary payout guidelines carry over from the plan to the inherited IRA, one account has annual RMDs in years 1 – 9, and the other does not.

Introducing chaos.

We know that consolidating inherited IRAs from the same decedent is allowed. If Lucy elects to combine the inherited accounts, which of the payout rules will take precedent? Does it matter if she transfers Inherited IRA X to Inherited IRA Z, or visa-versa? Does the fact that she has two different payout rules eliminate her ability to consolidate? And who on this planet will be responsible for tracking what assets came from which account and what payout period to follow?

And therein lies the problem.

Such a scenario is intriguing because it is not so far-fetched. Many plan participants are currently leveraging the still-working exception. A significant percentage of these same people also have IRAs. I suspect we will see this potentially confusing combination of inherited IRA and inherited 401(k) payout rules more frequently in the years to come. Future guidance from the IRS would certainly be welcome.

By Andy Ives, CFP®, AIF®
IRA Analyst