After a few years of confusion and waivers, the IRS released clarifying information on inherited IRAs in the summer of 2024. Before we unpack the latest information, let's recap the 2019 legislation.
In 2019, Congress passed the SECURE Act. This legislation included a host of changes to retirement plans, including distributions from inherited IRAs (Individual Retirement Accounts, traditional and Roth).
For the sake of brevity, we won't go into all of the rules for IRA beneficiaries, but one key change within the SECURE Act was ending the “stretch IRA” for many IRA beneficiaries, namely non-spouse beneficiaries (adult children, trusts, etc.).
Prior to the SECURE 2.0 Act, non-spouse individual IRA beneficiaries were allowed to “stretch” distributions from an inherited IRA over their own life expectancy following the original owner’s death. A minimum distribution amount was required each year based on the beneficiary’s age, but the SECURE Act changed the distribution requirements for these beneficiaries.
The 10-Year Rule
The SECURE Act introduced new withdrawal rules, including a 10-year distribution requirement.
For non-spouse beneficiaries that inherited an IRA in 2020 or later, the beneficiary must withdraw the entire IRA balance within 10 years.
The 10-year clock begins at the end of the year following the deceased IRA owner’s death. For example, if the decedent died in 2020, the 10-year clock began at the start of 2021 and will end in 2030.
While significant, the rule seemed simple enough until competing regulations were issued in 2021, outlined briefly below.
The Return of the Stretch Rule for Required Minimum Distributions
These proposed regulations stated that when the original account owner died after their Required Beginning Date (aka the RBD, which is the date Required Minimum Distributions (RMDs) were required to start), most non-spouse beneficiaries would need to follow the old “stretch” distribution rules and the new 10-year rule.
This was unexpected and came as a surprise to both taxpayers and tax professionals alike.
Due to the confusion, the IRS issued notices in 2021, 2022, 2023 and 2024 to waive any penalties related to missed RMDs from inherited IRAs. This effectively waived the requirement to take a required minimum distribution in those years.
The IRS Clears Up Confusion
If all of that sounds confusing, you aren't alone. In July 2024, the IRS released final regulations clarifying RMD rules for inherited IRAs.
While the final regulations addressed many open questions, the clarity provided to non-spouse beneficiaries of IRAs was the headline item.
The IRS confirmed that non-spouse beneficiaries that inherit an IRA from an original IRA owner passing after their Required Beginning Date must comply with the old “stretch” rule and the new 10-year rule. This means they are required to take a minimum distribution each year based on their age and fully withdraw the inherited IRA balance within a decade.
If the IRA owner died before their Required Beginning Date, the non-spouse IRA beneficiary only needs to follow the 10-year rule. Clear as mud?
The new rules discussed above are highlighted in the middle section (Non-Eligible Designated Beneficiary) of the graphic below.
Next Steps for Inherited IRA Beneficiaries
If you are an IRA beneficiary subject to the old “stretch” rule and the 10-year rule, what should you do?
First, consider the RMD waivers issued for 2021 – 2024. Those distributions are still waived, and therefore do not need to be taken.
However, beginning in 2025, required minimum distributions must be taken. Also, those waiver years do not extend the 10-year rule. The 10-year clock still begins the year after the death of the original account holder.
Second, your options may not be as binary as they seem. It’s possible that taking only the required distributions in years 1 through 9 after the year of death, with the remaining IRA balance withdrawn in year 10, nor withdrawing the IRA balance ratably over the 10-year period is the optimal strategy.
The final regulations provide an opportunity to engage in multi-year, strategic income tax planning.
IRA beneficiaries in the highest tax bracket are likely to benefit most from delaying inherited IRA withdrawals as long as possible while fulfilling the annual minimum distribution requirements.
IRA beneficiaries in lower tax brackets are likely to benefit most from varying distributions from year to year to reduce the total taxes paid over the entire 10-year period.
IRA beneficiaries should also consider that inherited IRAs can be used to make Qualified Charitable Distributions (QCDs) provided that the IRA beneficiary is 70 ½ or older.
If the IRA beneficiary is retired and enrolled in Medicare, the additional income from inherited IRA withdrawals can temporarily increase your Medicare premiums.
Final Thoughts
Without proper tax planning, inherited IRA assets can have unexpected consequences. If this all seems a bit daunting, it may be time to get a tax-strategy minded team on your side, which can include a wealth manager, a financial planner, and potentially a tax advisor.
The Plancorp team can run tax projections on the various scenarios outlined above and provide a recommendation.
Take our quick, 2-minute financial analysis today to get a gut-check on the health of your financial plan, curated resources based on your results, and a sense of whether partnering with a pro is right for you.
