Inherited an IRA? The SECURE Act Determines Whether You Get Five Years, Ten Years, or a Lifetime

If you have a retirement account, chances are you've filled out a beneficiary designation form and haven't looked at it since.

Unfortunately, that one-page form may have a bigger impact on your family's taxes than your entire estate plan.

Before 2020, most beneficiaries who inherited an IRA could "stretch" required minimum distributions over their own life expectancy. That often allowed retirement savings to continue growing tax-deferred for decades while spreading out the income taxes.

The SECURE Act changed those rules dramatically.

Today, who inherits your retirement account often matters just as much as how much is in it. Two people inheriting identical IRAs can face completely different tax treatment simply because they fall into different beneficiary categories.

Let's walk through those categories.

Category One: Eligible Designated Beneficiaries (EDBs)

Congress created a small group of beneficiaries who receive the most favorable treatment.

These are called Eligible Designated Beneficiaries, or EDBs.

Depending on the circumstances, these beneficiaries may generally take distributions over life expectancy instead of immediately becoming subject to the SECURE Act's ten-year payout rule.

The five categories are:

• surviving spouse

• the account owner's minor child

• disabled beneficiary

• chronically ill beneficiary

• beneficiary who is not more than ten years younger than the account owner

Example

Imagine James dies owning a $750,000 traditional IRA.

His wife inherits the IRA.

Because she is his surviving spouse, she generally has options unavailable to anyone else, including rolling the IRA into her own retirement account or remaining the beneficiary of the inherited IRA.

Those options can significantly affect taxes and retirement planning.

The Minor Child Exception

Many parents assume this applies to any child under 18.

It doesn't.

It applies only to the account owner's own minor child.

While the child qualifies, distributions may generally be calculated using the child's life expectancy.

Once the child reaches age 21, however, the favorable treatment generally ends and the ten-year distribution period begins.

Example

Maria dies leaving her IRA to her 12-year-old son.

He may generally take life expectancy distributions while he remains a qualifying minor.

When he turns 21, the clock changes.

The remaining IRA generally must be fully distributed by the end of the tenth year after he reaches age 21.

Disabled or Chronically Ill Beneficiaries

Beneficiaries who meet the IRS definitions of disabled or chronically ill may also qualify as Eligible Designated Beneficiaries.

These situations often involve Special Needs Trust planning because preserving government benefits may be just as important as minimizing taxes.

Not More Than Ten Years Younger

This is probably the least understood exception.

Many people assume every non-spouse is automatically subject to the ten-year rule.

That's not true.

If the beneficiary is not more than ten years younger than the account owner, that beneficiary may qualify as an Eligible Designated Beneficiary.

Interestingly, this also includes beneficiaries who are older than the account owner.

Example

Mark is 68.

His sister Susan is 64.

Because she is only four years younger, she may qualify as an Eligible Designated Beneficiary.

If Mark instead names his 35-year-old daughter, she generally falls into a completely different category and is typically subject to the ten-year rule.

Same IRA.

Different beneficiary.

Very different tax rules.

Category Two: Designated Beneficiaries

Most beneficiaries fall into this category.

This generally includes:

• adult children

• grandchildren

• nieces

• nephews

• friends

These beneficiaries are generally subject to the 10-year rule.

The inherited retirement account generally must be fully distributed by the end of the tenth year following the owner's death.

If the owner had already reached the applicable Required Beginning Date for required minimum distributions, annual distributions may also be required during years one through nine before the account is completely distributed in year ten.

Example

John dies leaving his $900,000 IRA to his 42-year-old daughter.

She cannot simply leave the account untouched for the rest of her life.

Instead, she generally must withdraw the entire balance by the end of the tenth year.

Because those withdrawals are taxable, deciding when to take them can have a significant impact on her income taxes.

Category Three: Non-Designated Beneficiaries

Not every beneficiary is a person.

Sometimes retirement accounts are left to:

• an estate,

• a charity, or

• a trust that does not qualify as a see-through trust under the IRS rules.

These are generally called Non-Designated Beneficiaries.

The applicable distribution rule depends on whether the retirement account owner died before or after reaching the Required Beginning Date (RBD) for required minimum distributions.

If the owner dies before the RBD...

The retirement account generally must be completely distributed by the end of the fifth calendar year following the owner's death.

Estate planners often refer to this as the Five-Year Rule.

Example

David dies at age 68 and accidentally names his estate as the beneficiary of his IRA.

Because he died before his Required Beginning Date, the IRA generally must be emptied within five years.

If the owner dies on or after the RBD...

A different rule generally applies.

Instead of the five-year rule, annual required distributions generally continue using the deceased owner's remaining IRS life expectancy.

Estate planning attorneys often refer to this as the "Ghost Life Expectancy" rule because the distribution period is based on the deceased owner's remaining life expectancy—not the beneficiary's.

Example

Carol dies at age 84 after beginning required minimum distributions.

Her estate inherits the IRA.

Rather than using the beneficiary's age, the required distributions generally continue using Carol's remaining IRS life expectancy factor.

Even though Carol has passed away, her remaining life expectancy continues to determine the payout schedule—hence the nickname Ghost Life Expectancy.

Although this rule may provide a longer payout period than an immediate lump sum, it generally offers less flexibility than naming an individual designated beneficiary.

What About Trusts?

Many people hear that trusts are "bad" retirement account beneficiaries.

That simply isn't true.

A properly drafted trust may qualify as a see-through trust, allowing the IRS to "look through" the trust and apply the distribution rules based on the trust's underlying beneficiaries.

Not every trust qualifies.

To receive this treatment, the trust must satisfy specific IRS requirements, and the resulting distribution rules can vary depending on whether it is drafted as a conduit trust or an accumulation trust.

For many families, naming a trust isn't primarily about taxes.

It's about protecting beneficiaries.

A trust can help:

• protect young beneficiaries

• provide professional management

• protect assets from creditors

• help preserve inheritances in the event of divorce

• coordinate retirement accounts with the overall estate plan

• provide flexibility when beneficiaries have special needs or struggle with financial management

The "right" beneficiary depends on the family's goals—not simply which option produces the lowest taxes.

Why Your Beneficiary Designation Matters

One of the biggest misconceptions in estate planning is that your will or trust controls everything.

Retirement accounts are different.

Your beneficiary designation usually controls who inherits the account.

That means an outdated beneficiary form can unintentionally override an otherwise carefully designed estate plan.

Marriage.

Divorce.

Births.

Deaths.

Children reaching adulthood.

Changes in tax laws.

All are good reasons to review beneficiary designations regularly.

The Bottom Line

The SECURE Act made inherited retirement accounts significantly more complex.

The difference between naming your spouse, your child, your sibling, your trust, or your estate can dramatically change how quickly retirement assets must be distributed and how much flexibility your beneficiaries have.

A beneficiary designation should never be an afterthought.

It is one of the most important—and often overlooked—parts of a comprehensive estate plan.

Educational Disclaimer: This article is intended for general educational purposes only and should not be considered legal, tax, or financial advice. Every family's circumstances are unique. Before changing your retirement account beneficiary designations, consult with your estate planning attorney, tax advisor, and financial professional.