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George F. Bearup, J.D. Senior Legal Trust Advisor

15-Jan-20

SECURE Act – The “At Least as Rapidly” Rule

Take-Away: The SECURE Act’s ‘new’ 10-year distribution rule has left many confused as to whether it replaces the Tax Code’s at least as rapidly distribution rule when the IRA owner dies after his/her required beginning date. It appears that despite the ‘new’ 10-year distribution rule, the at least as rapidly option to take distributions over the owner’s remaining life expectancy continues to be available with regard to taking distributions from an inherited IRA. However, the economics behind opting for the at least as rapidly distribution period may not provide much of a windfall to the IRA beneficiary who selects that at least as rapidly required minimum distribution option.

Background: Prior to the SECURE Act a designated beneficiary of an inherited IRA had to take distributions over the longer of (i) the remaining life expectancy of that designated beneficiary [now replaced with the 10-year rule]; or (ii) the remaining life expectancy of the deceased IRA owner. The latter of the two is called the at least as rapidly distribution rule; IRC 401(a) (9) (B) (i) (ll) provides (paraphrased): “the beneficiary of an IRA is entitled to use a distribution method that allows distributions to come out of the IRA ‘at least as rapidly’ as would apply if the IRA owner was living, but only if the IRA owner dies after reaching his or her required beginning date.”

The Regulations note that the beneficiary of an inherited IRA, for purposes of determining the distribution period of RMDs if the IRA owner dies on or after his/her required beginning date, is able to use the longer of either the remaining life expectancy of the designated beneficiary [just changed by the SECURE Act with its 10-year distribution rule for beneficiaries who are not classified as eligible designated beneficiaries] or the deceased IRA owner’s remaining life expectancy. [Treas. Reg. 1.401(a) (9)-5, Q&A-5.]

SECURE Act Ambiguity: The required beginning date was changed to age 72 under the SECURE Act. However, the SECURE Act did not modify or remove IRC 401(a) (9) (B) (i) (ll) which contains the at least as rapidly distribution option if the deceased IRA owner was older than his/her required beginning date.  Consequently, the question is whether the SECURE Act’s general 10-year distribution rule replaced the at least as rapidly distribution rule available to designated beneficiaries, since the Tax Code section where that distribution option exists was not changed by the SECURE Act. New IRC 401(a)(9)(H)(i)(ll) indicates that the 10-year distribution rules applies in place of the ‘old’ 5-year distribution rule where there is no designated beneficiary, regardless of whether the IRA owner died on or after his/her required beginning date.  However, that change was not extended to the at least as rapidly distribution option. Therefore it is unclear whether Congress intended to remove the at least as rapidly distribution option that appears in IRC 401(a) (9) (B) (i) (ll), as it was not expressly modified. Hopefully the anticipated Regulations will address this ambiguity.

Economics of the At Least as Rapidly Distribution Rule: The choice of following either a 10-year distribution period or opting to use the deceased IRA owner’s remaining life expectancy, which may be a few years longer than 10 years as the distribution period, may not produce the level of savings one might otherwise expect.

  • Example: Diane, age 73, dies. At her death, Diane’s IRA had a balance of $1.0 million. Diane’s daughter Beth is her sole IRA beneficiary. Assets grow in the IRA at 6% a year. Beth will pay income taxes on distributions from the inherited IRA at a 37% federal income tax rate. The net-of-tax distributions are invested by Beth and taxed at 1% per year, which results in a growth rate of 5% per year for the post-distribution investments held in Beth’s name.
  • 10-year Distribution: Under this distribution option, the combined value of the IRA and Beth’s investments after 5 years is $1,418,519; in year 10, the total value is $1,195,928. The value of the reinvested assets ‘outside’ the IRA’ after 15 years is $1,526,341. In year 20, the value of Beth’s investment assets is $1,948,041.
  • At Least as Rapidly Distribution: Under this distribution option, the corresponding values of the combined inherited IRA and the reinvested distributions are $1,207,460 after 5 years; $1,352,722 after 10 years; $1,481,523 after 15 years; and $1,897,438 after 20 years.
  • Observation: Note that the at least as rapidly distribution option becomes even less favorable the older the IRA owner is at the time of their death due to their shorter life expectancy. Under the example, Diane died at age 73, the first year after reaching her required beginning date. If Diane had died after age 80, her life expectancy would be less than 10 years.

Trustee’s Strategic Decision? Crazy as this sounds, what if an age 72 decedent’s IRA was made payable to a conduit see-through trust and the trustee wanted to pursue the at least as rapidly distribution rule, because it provides a slightly longer period in which to take IRA distributions. If that distribution option no longer exists, then the 10-year payout rule would apply to that see-through trust, and the trustee would be ‘stuck’ with the 10-year distribution option. If the trustee wanted to use the longer at least as rapidly distribution rule, could the trustee deliberately ‘fail’ the see-through trust requirements? For example, if the trustee does not deliver a copy of the trust instrument, or a summary of its beneficiaries, to the IRA custodian by October 1 of the year following the IRA owner’s death, then the trust would not qualify as a see-through trust, thus defaulting then to the at least as rapidly distribution rule. Should a trustee intentionally fail to meet the see-through trust rules in order to use the at least as rapidly distribution rule?

Impact of Change in Life Expectancy Tables: As reported earlier, the IRS’s required minimum distribution tables will change on January 1, 2021 to reflect the most recent life expectancy studies based on the 2010 Census results. With those new actuarial tables an IRA owner’s remaining life expectancy will be close to two years longer than 10 years if the owner dies between the ages of 73 and 80 years. That change that provides even longer life expectancies could also prompt a trustee to intentionally disqualify a see-through trust  in order to take advantage of the at least as rapidly ‘default’ distribution rule.

Conclusion: Hopefully many of the questions raised by the SECURE Act’s new 10-year distribution rule will be answered in the IRS’ Regulations that will be published sometime this year. In the meantime, it is probable that the at least as rapidly distribution period will still be available to designated beneficiaries of an IRA whose owner died after attaining age 72.