SECURE Act Proposed Regulations: The Concurrent Life Expectancy Trap

Take-Away: The SECURE Act’s Proposed Regulations create a potential trap that require the inheritor of an IRA to monitor concurrent life expectancies.

Background: The SECURE Act’s Proposed Regulations impose a complex requirement that forces a designated beneficiary to monitor the decedent’s phantom life expectancy and their own life expectancy when it comes to calculating required minimum distributions (RMDs) from an inherited IRA. The following example demonstrates how this could create a potential trap that leads to the 50% penalty for the designated beneficiary’s failure to take a required minimum distribution (RMD.)

Example: Shirley dies at age 75, which is after her required beginning date (RBD). This age at death dictates when RMD’s begin. Shirley’s designated beneficiary for her IRA is her older brother, Warren, who is age 80. Since Warren is not more than 10 years younger than Shirley, Warren can stretch RMDs from the inherited IRA. However, since Shirley died after her RBD, and Warren is older than Shirley, Warren is permitted to use Shirley’s single life expectancy to calculate his RMDs from the inherited IRA. Shirley’s life expectancy in the year of her death is 14.8 years-for a 75-year old individual. That factor is then used by Warren to calculate his RMDs from the inherited IRA. For subsequent years, Warren subtracts 1 each year. Consequently, the inherited IRA should last for 15 years until Warren is age 95. However, that is not the result under the Proposed Regulations.

Proposed Regulations:  The SECURE Act Proposed Regulations provided the following “explanation” [I think a better word would be obfuscation, but I digress:}

“…these proposed regulations require a full distribution of the employee’s [account owner’s] remaining interest in the plan [or the deceased owner’s IRA] in the calendar year in which the life expectancy factor would have been less than or equal to one if it were determined using the beneficiary’s remaining life expectancy (even though the life expectancy factor for determining the required minimum distribution is based on the remaining life expectancy of the employee [or the deceased owner’s IRA.]”

Going Back to the Example: Even though Warren is using Shirley’s life expectancy factor (14.8 years) to calculate his annual RMDs from the inherited IRA, Warren must also monitor his own life expectancy factor to determine when he must empty the inherited IRA. Had Warren used his own life expectancy to calculate RMDs, he would have started with 10.5 years (the factor for Warren’s age in the year after Shirley’s death- age 81. Eleven years later, Warren’s own life expectancy factor would have been down to 0.5. Since 0.5 is less than one, Warren is required to empty the inherited IRA at age 91, not age 95. This is true, even though Shirley’s life expectancy still had four years remaining and it was the life expectancy that Warren had been properly using to calculate his own RMDs from age 81 to 91.

Conclusion: The Preamble to the Proposed Regulations tell us that these Regulations are intended to simplify and provide clarity to the SECURE Act and its distribution provisions. The above example is anything but clear or simple. A designated beneficiary in Warren’s shoes could easily assume that he had until age 95 to empty the IRA that he inherited on his sister’s death, thus triggering a 50% penalty for the failure to take a ‘final’ RMD. I’m pretty sure my idea of simplification is not shared by the IRS.