IRS Finalizes Guidance on Treatment of Inherited IRAs
July 26, 2024
Estimated Reading Time: 5 Minutes
The IRS has recently issued final regulations clarifying the rules around Required Minimum Distributions (RMDs) for inherited IRAs. These updates provide crucial insights for beneficiaries navigating the complexities of inherited retirement accounts, particularly due to the SECURE Act and subsequent regulatory changes. Here’s a detailed look at what these final regulations mean for you as a beneficiary.
Understanding RMDs and the New Regulations
By law, individuals must start withdrawing funds from their retirement accounts annually once they reach age 73 (rising to 75 in 2033). This required withdrawal amount is known as the Required Minimum Distribution (RMD). The amount is calculated by dividing the previous year's end-of-year account balance by the account holder’s life expectancy, found in IRS Publication 590-B.
For inherited IRAs, the SECURE Act significantly altered the distribution landscape. Previously, beneficiaries could stretch distributions over their own life expectancy, minimizing tax impact. However, the SECURE Act introduced the 10-year RMD rule, mandating that all assets in the inherited IRA be fully withdrawn within ten years following the original owner’s death. This change aimed to accelerate the distribution timeline, impacting tax planning strategies.
Annual Distributions Under the 10-Year Rule
After years of uncertainty, the IRS finalized rules on Thursday to make clear that people who inherit retirement accounts have 10 years to spend down the funds. In many cases, there is a minimum amount they must spend each year. This requirement addresses prior confusion where some beneficiaries believed they could defer distributions until the end of the 10-year period.
Transitional Relief
Recognizing the confusion caused by the new rules, the IRS provided relief for missed RMDs in 2021, 2022, and now 2023 and 2024. Beneficiaries who failed to take required distributions in these years will not face penalties, and those who paid penalties can request refunds.
Eligible vs. Ineligible Beneficiaries
The 10-year rule applies to 401(k)s, IRAs, and other pre-tax contribution plans inherited on or after January 1, 2020. It does not apply to beneficiaries who are eligible designated beneficiaries (EDBs), meaning spouses and minor children, as well as those who are not more than 10 years younger than the deceased, and disabled or chronically ill beneficiaries. Eligible beneficiaries can take distributions over their life expectancy or opt for the 10-year rule. Ineligible beneficiaries, typically adult children or grandchildren, must adhere strictly to the 10-year rule.
Trusts as Beneficiaries
The regulations uphold the see-through trust concept, allowing certain trusts to qualify as designated beneficiaries, provided they meet specific criteria. This provision ensures that trusts can manage the timing of distributions in a tax-efficient manner.
Implications for Financial Planning
These regulations underscore the importance of strategic planning for inherited IRAs. Beneficiaries and their advisors must carefully consider the timing of distributions to minimize tax liabilities and comply with RMD rules. The relief provisions offer some breathing room, but understanding and applying these rules correctly is crucial to avoid costly penalties.
Action Steps
Review Inherited IRA Accounts: Ensure you understand the RMD requirements based on the year of inheritance and the original account holder’s RMD status.
Consult with Professionals: Given the complexity and potential tax implications, consulting with a financial advisor is highly recommended to navigate these regulations effectively.
Plan for Future Distributions: Develop a strategy for annual distributions to avoid penalties and optimize tax outcomes.
The Fine Print
Like with any tax law change, there are several nuances and exceptions to the law that make it advantageous to work with a financial advisor who can explain them. For example, while most non-spouse beneficiaries must spend down the accounts in 10 years, they only have a required minimum distribution (RMD) each year if the decedent was past the RMD age. The rule today also doesn’t affect those who weren’t the RMD age, which is now 73 years old. Beneficiaries will want to carefully plan out how much they want to withdraw each year, as the withdrawals are treated as taxable income.
Conclusion
The IRS’s final regulations on inherited IRAs provide much-needed clarity but also highlight the intricacies of managing these accounts under the SECURE Act. Beneficiaries should take advantage of the transitional relief and seek professional guidance to ensure compliance and optimize their financial strategies. As always, staying informed and proactive is key to successful retirement and inheritance planning.
By staying abreast of these regulatory changes, beneficiaries and advisors can better navigate the evolving landscape of inherited IRAs, ensuring financial stability and compliance with IRS requirements.
1Internal Revenue Service. “About Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs)” IRS, 2024, https://www.irs.gov/forms-pubs/about-publication-590-b. Accessed 26 July 2024.
2Internal Revenue Service. “Treasury, IRS issue updated guidance on required minimum distributions from IRAs, other retirement plans; generally retains proposed rules” IRS, 2024, https://www.irs.gov/newsroom/treasury-irs-issue-updated-guidance-on-required-minimum-distributions-from-iras-other-retirement-plans-generally-retains-proposed-rules. Accessed 26 July 2024.
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