Some of you may remember this question from our October 2022 newsletter. At that time, we were waiting for the IRS’ proposed regulations to be signed into law. On July 18, 2024, the IRS issued the long-awaited final regulations governing inherited IRAs, and thus we wanted to offer an update.
As a reminder, an individual retirement arrangement (IRA), or more commonly referred to as an “individual retirement account,” is a tax-deferred investment account that helps you save for retirement. If you inherit an IRA, Required Minimum Distribution (RMD) rules may apply, and the amount and timing of these RMDs depend on your relationship to the account owner.
NON-SPOUSE BENEFICIARIES AND THE 10-YEAR RULE
Historically, non-spouse beneficiaries had several options, including the ability to “stretch” the RMDs out over their life expectancy. In 2020, the SECURE Act modified these rules to require inherited IRAs be fully distributed within 10 years (“10-Year Rule”). For example, a non-spouse beneficiary who inherits an IRA from someone who passes away in September 2024, must distribute the entire inherited IRA by December 31, 2034, the end of the 10th year after the original IRA owner’s passing. This led to the question, “do distributions need to be taken annually or can the entire IRA be liquidated in Year 10?” Over the past four years, the common interpretation of the law did not require the beneficiary to take an annual distribution from an inherited IRA. These final regulations provide additional clarity around this question.
TRADITIONAL IRAs
Traditional IRAs are tax-deferred accounts – meaning that income taxes are owed when distributions are taken out of the IRA. The IRS generally requires distributions to be made after the IRA account owner reaches their “required beginning date” (currently age 73). The final regulations state that if a non-spouse beneficiary inherits an IRA from someone who died before reaching their “required beginning date” (i.e., the owner had not yet been required to take RMDs), the beneficiary does not have to take RMDs in Years 1 through 9, but must liquidate the inherited IRA by the end of Year 10. Conversely, if a non-spouse beneficiary inherits an IRA from someone who had already begun taking their RMDs when they passed away, the beneficiary must continue taking annual distributions and liquidate the IRA by Year 10. The annual RMD amount is generally based on the non-spouse beneficiary’s single life expectancy. However, using this RMD amount may not be enough to ensure the inherited IRA is liquidated by the end of Year 10. Thus, larger annual distributions may be required. Further, the IRS confirmed that non-spouse beneficiaries who would have been required to take distributions in the years 2021-2024 but did not, will not be penalized or required to make up any missed distributions. Thus, the final regulations effectively start with RMDs to be taken in 2025.
ROTH IRAs
Non-spouse beneficiaries of inherited Roth IRAs are not required to take annual distributions, but they are still required to liquidate the inherited Roth IRA by the end of Year 10.
WHO IS EXEMPT FROM THE 10-YEAR RULE?
Certain IRA beneficiaries may be exempt from the 10-Year Rule. These include the surviving spouse, children who have not reached the age of majority (age 21), those who are chronically ill or disabled, and beneficiaries who are not more than 10 years younger than the original IRA owner. These beneficiaries may be able to “stretch” the IRA beyond 10 years, potentially over their life expectancy. In addition, those that inherited an IRA prior to 2020 may also be exempt, as the Rule became effective for IRAs inherited after December 31, 2019.
If you have inherited an IRA, we recommend that you reach out to our team or your tax advisor to discuss your situation and determine what distribution strategy is most tax-efficient for you.
Author: Marc Verdi, CPA/PFS, CFP® | Director of Tax & Financial Planning
Written: August 30, 2024