If you inherited a retirement account as a designated beneficiary in 2019, you are now afforded another chance to override the 5-year rule and instead opt to take distributions from the account over your life expectancy. The original deadline of December 31, 2020, to take that action has been extended to December 31, 2021.[i] If you fall into that category, you may not be alone if you’re confused by the new rules and deadlines, but you need to understand what the requirements are to determine an appropriate strategy for you.
First, a Little Background
In early 2020, the Secure Act was signed into law, changing the way beneficiaries will receive proceeds from an inherited retirement account. Until the new law was passed, beneficiaries were able to roll money received from a qualified retirement account into an inherited IRA and stretch withdrawals from the account over their life expectancy.[ii] Required minimum distributions (RMDs) from the account are based on the beneficiary’s age, life expectancy, and amount of money in the account.
That was important because it allowed the beneficiary to take small withdrawals over time, which meant paying fewer taxes each year. Under the RMD rules, the account would have to be emptied by the time the beneficiary reached life expectancy. Under the new rules established in the SECURE Act, the stretch IRA provision is no more, which could mean higher taxes, especially if beneficiaries are in their peak earning years.[iii]
New 5-Year Rule
Under the Secure Act, if you were the beneficiary of assets held in an employer-sponsored retirement plan in 2019, you may be required to fully empty the account within five years. However, with the passage of the Coronavirus Aid, Relief, and Economic Security (CARES) Act last year, the 5-year period will not count the year 2020. That means, if you inherited a retirement account between 2015 and 2019, you have six years instead of five to empty your account.[iv]
Overriding the 5-Year Rule[v]
With most employer-sponsored plans, the plan document’s terms may offer the designated beneficiary the option to choose between the 5-year rule or the life expectancy rule. To be eligible for the life expectancy option, the plan participant must have died before the required beginning date (RBD) for withdrawals. The RBD is April 1 of the year following the year the participant reached age 70 ½. Some plan documents allow for the deferral of the RBD until April 1 of the year following the year the participant separates from service.
Ordinarily, you must make your election by December 31 of the year following the year of the participant’s death. However, suppose your employer plan doesn’t offer the option to take distributions over your life expectancy. In that case, you can do a direct rollover of the plan assets into an inherited IRA, which does allow for life expectancy distributions. The rollover must occur by December 31 of the year following the year of the participant’s death. The SECURE Act was amended to extend the rollover deadline to December 31, 2021.[vi]
Note: To qualify for life expectancy distribution, it must be a direct rollover in which the money is sent directly to the inherited IRA.[vii]
The Time to Act is Now
The new 5-year rule and the rules for overriding it are somewhat more complex than what can be explained here. You should first determine your eligibility by contacting your financial advisor, who can also work with you to help calculate your withdrawals under the life expectancy option. If you want to choose the life expectancy option but your plan sponsor doesn’t offer it, you need to contact the plan administrator to initiate a direct rollover into an inherited IRA well before December 31, 2021.vi
[i] https://www.forbes.com/sites/deniseappleby/2021/05/26/2021-is-the-last-opportunity-to-override-5-year-rule-and-stretch-distributions-for-401ks-inherited-in-2019/?sh=2d22a892224a 10 August 2021
[ii] Ibid.
[iii] https://www.forbes.com/sites/deniseappleby/2021/05/26/2021-is-the-last-opportunity-to-override-5-year-rule-and-stretch-distributions-for-401ks-inherited-in-2019/?sh=2d22a892224a 10 August 2021
[iv] Ibid.
[v] Ibid.
[vi] https://www.forbes.com/sites/jamiehopkins/2021/12/31/how-retirement-planning-changes-in-2021-after-the-new-covid-19-relief-package/?sh=38e77a614bba 10 August 2021
[vii] https://www.irs.gov/publications/p590b 10 August 2021