Prior to 2019, most beneficiaries of Inherited IRAs could stretch out Required Minimum Distributions (RMDs) over their lifetime. However, the first SECURE Act eliminated this benefit and required that most non-spouse beneficiaries empty inherited accounts within 10 years. This change led to considerable confusion, most notably, whether annual RMDs were necessary during this 10-year period. As a result of the confusion, the IRS waived RMDs from Inherited IRAs for the past three years. However, earlier this month the IRS issued final regulations for anyone that inherited an IRA in 2020 and thereafter.
IRS Final Regulations, required for any non-spousal IRA inherited in 2020 and later:
- If Deceased IRA Owner Had Started RMDs:
- Most beneficiaries must withdraw funds within 10 years beginning the year after death.
- Annual RMDs for each of the 10 years beginning the year after death.
- Caution: Small annual withdrawals could lead to a large, taxable distribution in the final year to draw down the balance to $0.
- If Deceased IRA Owner Had Not Started RMDs:
- No annual RMDs, but the account must be empty by the end of year 10.
- Most beneficiaries can withdraw any amount, or $0, a year over 10 years.
- Caution: Waiting until the 10th year could lead to a large, taxable distribution in the final year to draw down the balance to $0.
For inherited IRAs requiring distributions since 2020, the 10-year clock has already started, however the IRS waived all penalties for failure to take RMDs through 2024 due to previous regulatory uncertainty.
For beneficiaries that inherited multiple IRAs:
- Different rules may apply to different inherited accounts.
- Careful management of each account is important.
For beneficiaries that inherited an IRA prior to 2020:
- These accounts remain subject to the old “stretch” IRA rules, allowing withdrawals over the beneficiary’s lifetime.
Important Takeaways:
- Tax Planning: Work closely with your tax preparer and Rockbridge Financial Advisor to develop a withdrawal strategy that minimizes your tax burden. Taking only the minimum distribution each year could result in a significant tax hit in the final (10th) year. In certain situations, it may make sense to delay significant withdrawals; for example, if you are nearing retirement and income will decrease significantly in the future.
- Account Inventory: If you’ve inherited multiple IRAs, carefully review the rules applicable to each account. Different inheritance dates may mean different withdrawal requirements.
- Spousal Exemption: These new regulations generally do not affect spouses who inherit IRAs, as they have special rules allowing them to treat the inherited IRA as their own.
Whether you’ve recently inherited an IRA or inherited an IRA prior to 2020, it’s important to understand your obligations and strategize accordingly.
Note that a separate set of rules applies to beneficiaries of Inherited IRAs who are a surviving spouse, minor child, person not less than 10 years younger than the decedent, or persons that are disabled or chronically ill.
Given the potential tax implications and the complexity of these rules, consulting with your Rockbridge Financial Advisor and tax professionals is highly recommended to minimize your tax burden and ensure compliance with IRS regulations to avoid penalties up to 25%.