SECURE 2.0 was enacted as part of the Consolidated Appropriations Act, 2023. It introduces a significant number of changes to retirement preparation including, contributions, simplicity of participation, and the date for beginning Required Minimum Distributions (RMD). There is a significant new provision for the surviving spouse of a deceased participant in an employer retirement plan. The new law enhances tax treatments for surviving spouses, especially those married to a younger spouse.
Existing law. Under the current law, when a surviving spouse inherits a retirement account from a deceased spouse, they have a variety of options at their disposal that are not available to any other beneficiary. In general, they can:
· Roll the decedent’s IRA or Retirement Plan into their own IRA
· Treat the decedent’s IRA as their own, or
· Remain a beneficiary of the decedent’s IRA, but with special treatment
Each of these options offers certain advantages, based on the ages and financial circumstances of both the survivor and the deceased spouse.
New rule. Beginning in 2024, SECURE 2.0 adds an important new option to the list of spouse-beneficiary-only options by allowing the surviving spouse to elect to be treated as the deceased spouse.
Making this election would provide the following benefits to the surviving spouse:
- RMDs for the surviving spouse would be delayed until the deceased spouse would have reached the age at which RMDs begin (73 or 75, depending on the year of death);
- Once RMDs of the decedent would be required, the surviving spouse will calculate their RMDs using the Uniform Lifetime Table that is used by account owners, rather than the Single Lifetime Table that applies to beneficiaries, which has a longer life expectancy; and
- If the surviving spouse dies before RMDs begin, the surviving spouse’s beneficiaries will be treated as though they were the original beneficiaries of the IRA. This would allow any Eligible Designated Beneficiaries to ‘stretch’ distributions over their life expectancy instead of being stuck with the 10-Year Rule that normally applies.
Example: In 2024, Emily will be 57, and married to Harris, who will be 67. They have two children, Malcolm (31) and Sydney (29). Emily has an IRA worth $1M. Emily unfortunately dies of an illness on January 2, 2024. Harris’ options are as follows:
Option 1: Roll the $1M into his IRA. Harris can roll over Emily’s IRA as his IRA and It will be subject to the IRA rules. He’ll have Required Minimum Distributions when he reaches age 73 (SECURE 2.0 changes the RMD age to age 73 in 2023), or 2028. The IRA will grow tax-deferred. When he dies, if he leaves her IRA to the children, they will be subject to the 10-year rule: the funds must be distributed, and taxed, within 10 years after the death of the IRA owner.
Option 2A: Inherited IRA: Life Expectancy. Here Harris would create an inherited IRA and be able to take distributions. He would use the IRS Single Life Table, and could start taking the RMDs the later of:
· Probably when Emily would have attained age 75 (SECURE ups the RMD age to 75 after 2033); or
· 12/31/2025
Under the Single Life Table, Harris would use the life expectancy for him for the year 2025 (the year after Emily’s death). Harris would have to take RMDs at least by 12/31/2042 the year Emily would have attained age 75 (it appears this would be the rule). He could take them earlier. When Harris dies, if he leaves the IRA to the children, they will have to take the funds out under the 10-year rule. This option would be beneficial if Harris wanted a longer compounding period.
Option 2B: Inherited IRA – 10-year. Under this option, Harris would create an inherited IRA and take the funds out within 10 years. This option would allow some flexibility of distributions, like leaving funds until a later date at which time he would be in a lower tax bracket.
Option 3: New Rule. Under the new rule, Harris could elect to be treated as Emily for purposes of the IRA. He could then use the more advantageous Uniform Lifetime Table to compute the RMD life expectancy. This is quite similar to Option 2 above, where Harris would be able to defer RMDs on Emily’s IRA until she would have had to have taken them (apparently her age 75) and with a significant addition: If Harris dies before the RMDS begin (12/31/2042, the kids would be treated as primary beneficiaries of the account and could stretch distributions over their life expectancies.
The new rule allows the use of a better life expectancy table (in this case, 24.6 versus 20.4) and allows the children to be treated as primary beneficiaries.
While Regulations will be needed to further flesh out details of this new option (like the RMD age), at first glance, it would appear that its primary use case will be for surviving spouses who inherit retirement accounts from a younger spouse. By electing to treat themselves as the decedent, they will be able to delay RMDs longer, and once RMDs do start, they will be smaller than if the spouse had made a spousal rollover or remained a beneficiary of the account. It’s a bit morbid to go through the exercise, but there are apparently two things inevitable: death and taxes, and this new rule can help a bit with one of those. As always, I’ll try to answer questions, llabrecque@sequoia-financial.com.