The IRS has recently finalized regulations for inherited Individual Retirement Accounts (IRAs), clarifying a previously confusing area of retirement planning since Congress passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act.
These new rules, which will take effect in 2025, significantly impact how beneficiaries must handle inherited retirement accounts. Because of the newly finalized rules, many beneficiaries will likely need guidance from financial professionals to ensure they follow them.
The 10-Year Rule
At the heart of these new regulations is the “10-year rule,” which applies to most non-spouse beneficiaries who inherit IRAs from account holders who passed away after 2019. This rule requires that the entire balance of the inherited IRA is withdrawn by the end of the tenth year following the year of the original account holder’s death.
Before the original SECURE Act, passed in 2019, all beneficiaries could “stretch” the IRA over their lifetimes, significantly increasing the benefit of deferring taxes within the accounts. Now that accounts need to be emptied in ten years or less, inheriting these accounts could cause beneficiaries to jump into higher tax brackets. They could also impact other Federal benefits such as Medicare and the taxability of Social Security benefits.
Annual Required Minimum Distributions (RMDs)
One of the most significant clarifications in the new regulations is the requirement for annual Required Minimum Distributions (RMDs) within the ten years that beneficiaries have to empty the account. This applies specifically to cases where the original account holder had already started taking RMDs before they passed away.
In other words, if the original account holder was already taking RMDs from their account before they passed away, the beneficiary(s) will also need to continue taking distributions from the account during the 10-year period while the account is being emptied.
Exceptions to the Rules
It’s important to note that there are exceptions to these new rules. The following “eligible designated beneficiaries” are generally exempt from the 10-year rule:
- Surviving spouses
- Minor children (under age 21) until they are no longer minors
- Disabled or chronically ill individuals
- Beneficiaries not more than ten years younger than the deceased
Implementation Timeline
While the regulations are finalized, they won’t take effect until 2025. However, it’s crucial to understand that the 10-year period for deaths after 2019 has not been extended. For example, if an account owner died in 2020, the 10-year period would still end in 2030, not 2034.
Penalty Relief for Missed RMDs
The IRS has provided a grace period for affected beneficiaries. For 2021 through 2024, those subject to the new rules don’t have to take RMDs. This relief acknowledges the confusion surrounding the transition to the latest regulations.
Tax Implications and Planning Considerations
These new rules can have significant tax implications. As mentioned above, withdrawals from pre-tax inherited accounts are subject to standard income taxes. Our CERTIFIED FINANCIAL PLANNER® professionals typically advise beneficiaries to consider larger withdrawals earlier, especially while tax rates remain lower or if they will be retiring soon after they retire and are in a lower tax bracket. However, every individual beneficiary’s situation is unique and should have a personalized withdrawal plan.
Calculating RMDs
Starting in 2025, certain heirs will need to begin annual RMDs from inherited accounts. Understanding how to calculate your upcoming RMD is crucial, as custodians may not provide this information.
Penalties for Non-Compliance
Failure to take the required annual RMDs or not withdrawing an adequate amount may result in a 25% penalty on the shortfall. This penalty can be reduced to 10% if the RMD is “timely corrected” within a two-year window.
Action Steps for Beneficiaries
- Determine if you’re subject to the 10-year rule or if you qualify as an eligible designated beneficiary.
- If subject to the 10-year rule, start planning for annual RMDs beginning in 2025.
- Consider the tax implications of your withdrawal strategy and consult with a financial advisor or tax professional.
- Keep track of the 10-year deadline based on the year of the original account holder’s death.
- Stay informed about any future updates or changes to these regulations.
These new rules represent a significant shift in how inherited IRAs are managed. While they aim to simplify the process in the long term, they require careful planning and understanding in the short term. As always, you should consult with a financial professional to determine the best strategy for your specific situation.
Recent Comments