The SECURE Act of 2019 brought new rules for Inherited IRAs, effectively ending the "Stretch IRA" provision that allowed beneficiaries to spread distributions over their lifetimes. Initially, there was considerable confusion due to a lack of clarity around these changes. Now, after five years, the IRS has finally provided guidance on the regulations for inherited IRAs.
Before 2020, IRA owners could pass their accounts to their children, grandchildren, and other beneficiaries, who could stretch required minimum distributions (RMDs) over their lifetimes. Under the new "10-Year Rule", beneficiaries of the inherited IRA must fully deplete the account within 10 years after the original owner's death. This rule applies to both traditional and Roth IRAs.
Here are the five key points you need to know:
Distinction Based on RMD Start Date
If the original IRA owner dies before their Required Minimum Distribution (RMD) start date, beneficiaries have flexibility. They can choose to withdraw the entire amount in year 10, take distributions annually, or skip some years, as long as the account is fully depleted by the end of the 10th year. However, if the owner dies on or after their RMD start date, beneficiaries must take annual RMDs over the 10-year period, starting the year after the owner’s death.
Annual RMD Calculation
Non-eligible designated beneficiaries - including most non-spouse beneficiaries and some trusts benefiting those beneficiaries - must take annual RMDs based on their own life expectancy. The account must be fully depleted by December 31st of the 10th year following the original owner's death. Younger beneficiaries will have smaller annual RMDs but can withdraw more if they choose.
Relief for Missed RMDs (2020-2023)
Beneficiaries of IRAs where the original owner was already taking RMDs and who missed payouts between 2021-2024 won’t face penalties or need to make up the missed distributions. Starting in 2025, they calculate the RMD based on the life expectancy factor at the beginning of the 10-year period, minus one for each subsequent year.
Example of Missed RMD Relief: If a beneficiary inherited an IRA in 2022 and missed RMDs in 2023 and 2024, they only need to start taking distributions in 2025 and must fully deplete the account by the end of 2032.
Roth IRA Beneficiaries
The 10-year rule applies to Roth IRA beneficiaries, but they are not required to take annual RMDs within the 10-year period. Moreover, similar to the original Roth IRA owners, distributions taken by Roth beneficiaries are tax-free.
Missing an RMD Will Result in Penalties
Missing an RMD will result in a penalty of 25% of the amount that was supposed to be withdrawn.
How New Inherited IRA Rules Affect You
If you've inherited an IRA or expect to, these new rules will likely affect you. Beneficiaries must fully withdraw the IRA by the end of the 10th year, which could lead to significant taxable income. Since RMDs are based on your life expectancy, they might not deplete the IRA by end of the 10 years - so it may be to withdraw more than the minimum each year to spread the tax burden over the 10-year period.
Understanding these changes is vital for updating your financial plan, and proactive tax planning is key to shielding your heirs from substantial future tax burdens.
Please refer to the new flowchart we have created. If you have any questions about the new Inherited IRA rules, feel free to contact us. We're here to help!
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