How Does a Multigeneration IRA Work?

A multigenerational Individual Retirement Arrangement (IRA) is a financial planning strategy, not a distinct account type, designed to transfer retirement assets to heirs in a tax-efficient manner. This approach allows funds to continue growing tax-deferred or tax-free for as long as possible. The framework for this strategy was significantly reshaped by the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, which largely eliminated the “stretch IRA” concept that previously allowed beneficiaries to take distributions over their own lifetimes. Understanding the current regulations is necessary for any multigenerational wealth transfer plan involving IRAs.

Understanding Post-SECURE Act Beneficiary Rules

The most significant change from the SECURE Act is the 10-year rule, which applies to most non-spouse beneficiaries. This rule mandates that the entire balance of an inherited IRA must be distributed by the end of the tenth year following the original account owner’s death. Beneficiaries can take distributions at any time within this decade, as long as the account is empty by the deadline. This change accelerates the taxation of inherited assets.

A detail of the 10-year rule depends on whether the original owner had started taking Required Minimum Distributions (RMDs). If the owner died after their required beginning date for RMDs, the beneficiary must take annual distributions during years one through nine, in addition to emptying the account by the 10-year mark. If the owner died before starting RMDs, the beneficiary only needs to deplete the account by the end of the tenth year.

The law provides exceptions to the 10-year rule for a group known as Eligible Designated Beneficiaries (EDBs). These individuals can take distributions from the inherited IRA over their own life expectancy, similar to the old “stretch” provisions. This allows for a much longer period of tax-deferred growth compared to other beneficiaries.

Surviving Spouses

A surviving spouse who inherits an IRA has the most flexibility. The most common option for a surviving spouse is to roll over the inherited IRA assets into their own IRA. This action treats the funds as their own, allowing them to delay distributions until they reach their own RMD age and preserving the account’s tax-deferred status.

Minor Children of the Account Owner

The minor children of the original account owner can take distributions based on their own life expectancy until they reach age 21. Once the child turns 21, the 10-year rule is triggered. The remaining balance in the inherited IRA must be fully distributed by the end of the tenth year after they turn 21.

Disabled or Chronically Ill Individuals

Beneficiaries who are determined to be disabled or chronically ill when the account owner dies can take distributions over their life expectancy. This allows the account to provide long-term financial support. The Internal Revenue Code has specific definitions for these conditions, and proper documentation is required to prove eligibility for this exception.

Individuals Not More Than 10 Years Younger

Any individual who is not more than 10 years younger than the deceased IRA owner can also stretch distributions over their own life expectancy. This often applies to siblings or unmarried partners who are close in age to the account owner, allowing them to use rules similar to those that existed before the SECURE Act.

Using Trusts as IRA Beneficiaries

Naming a trust as an IRA beneficiary is a strategic choice for individuals seeking greater control over their assets after death. This can protect assets from a beneficiary’s creditors or ensure funds are managed responsibly for someone who is young or lacks financial experience. A trust allows the original account owner to dictate the terms of how and when the inherited IRA funds are distributed.

For a trust to be effective, it must meet IRS requirements to be considered a “see-through” or “look-through” trust. When these conditions are met, the IRS will “look through” the trust to the underlying beneficiaries to determine the distribution schedule. The requirements are:

• The trust must be valid under state law.
• The trust must be irrevocable upon the owner’s death.
• The trust must have identifiable individual beneficiaries.
• The IRA custodian must be provided with a copy of the trust documentation.

Conduit Trusts

A conduit trust, or pass-through trust, acts as a pipeline for IRA distributions. The trust document requires that any distribution the trust receives from the inherited IRA must be immediately paid out to the trust’s beneficiary, who is then responsible for paying the income tax.

The distribution schedule for a conduit trust depends on the status of its beneficiary. If the beneficiary is an EDB, the trust can take distributions over that person’s life expectancy. If the beneficiary is not an EDB, the 10-year rule applies to the trust.

Accumulation Trusts

An accumulation trust offers more control to the trustee, who is not required to immediately distribute funds received from an inherited IRA. The trustee can receive the IRA distribution and decide whether to pay it out to the beneficiary or retain it within the trust according to the grantor’s terms. This can be useful for protecting assets or managing them for a beneficiary over a longer period.

The primary drawback of an accumulation trust is its tax treatment. If the trustee retains the IRA distribution within the trust, that income is subject to trust tax rates. These rates are highly compressed, reaching the highest marginal tax rate at a much lower income level than individual tax rates, which can result in a significantly higher tax bill.

Information and Decisions for Your Strategy

Developing a multigenerational IRA strategy requires gathering specific information for every potential beneficiary. You will need to collect the following for the IRA custodian’s records:

• Full legal name
• Date of birth
• Social Security Number
• Correct physical address
• A clear definition of their relationship to you

If you plan to use a trust, you will need to work with an attorney to draft a document that reflects your goals. This involves deciding who will act as the trustee and what instructions they will have for managing and distributing the inherited IRA assets. These provisions will determine whether the trust functions as a conduit or an accumulation trust, impacting how beneficiaries receive funds and how those funds are taxed.

A strategic decision in this process is whether to convert some or all of a traditional IRA to a Roth IRA. A Roth conversion requires you to pay income tax on the converted amount in the current year, but future qualified distributions for you and your beneficiaries will be tax-free. To make this decision, analyze your current marginal tax rate compared to the likely future tax rates of your beneficiaries. Using funds outside your IRA to pay the conversion tax can prevent passing a large tax burden to the next generation.

The Process of Updating Beneficiary Designations

After gathering information and making strategic decisions, you must formally update your beneficiary designations. You will need to obtain the correct beneficiary designation form from the financial institution that serves as the custodian of your IRA. These forms are often available for download on the custodian’s website, or you can request a physical copy.

You will need to enter the specific information for each primary and contingent beneficiary you have chosen. Submission methods vary by custodian; many offer secure online portals, while others may require you to mail a physical form. Some transactions may require a signature guarantee, which is a certification you can get from a bank. If you have named a trust as your beneficiary, you must submit a copy of the trust documents to the IRA custodian with the designation form. After submitting all forms, you should receive a confirmation that your beneficiaries have been updated. Request a copy of the processed form for your records.