Understanding the New IRS Regulations on Inherited IRAs
Posted by Robert Ingrasci on August 15, 2024
If you've recently inherited an IRA, it's crucial to stay informed about the latest IRS regulations that impact how and when you must withdraw funds. A significant tax law changes in 2019 effectively ended the "stretch IRA" strategy by mandating that most non-spouse beneficiaries withdraw the entire balance within 10 years. Since then, confusion has abounded regarding the "10-year rule" and its implications for required minimum distributions (RMDs).
The IRS has now issued final regulations that clarify these rules for taxpayers who are subject to the 10-year withdrawal requirement from inherited IRAs or defined contribution plans, such as 401(k) plans. These final regulations largely adopt the proposals issued in 2022, which had previously caused considerable confusion.
The 2022 Proposed Regulations and Their Impact
The Setting Every Community Up for Retirement Enhancement (SECURE) Act, enacted in 2019, requires most heirs—except surviving spouses—to withdraw the entire balance of an inherited IRA or defined contribution plan within 10 years of the original account holder's death. However, when the IRS issued proposed regulations in February 2022, many beneficiaries were caught off guard by an unexpected requirement. Under these proposed rules, if the account owner died on or after their required beginning date (RBD), designated beneficiaries would need to take taxable RMDs annually from Year 1 through Year 9, based on their life expectancies, and receive the remaining balance in the 10th year.
This change meant that beneficiaries could no longer wait until the end of the 10-year period to take a lump-sum distribution, thereby reducing their tax planning flexibility. For some, this could lead to higher tax brackets during those years.
The proposed regulations generated a wave of confusion among taxpayers who had recently inherited IRAs or defined contribution plans. Uncertainty about when RMDs needed to begin left beneficiaries and plans vulnerable to penalties. Beneficiaries faced the risk of tax penalties on undistributed amounts, while plans could be disqualified for failing to enforce RMDs.
In response to the widespread confusion, the IRS issued waivers in 2022 and 2023 to prevent penalties for beneficiaries who missed RMDs in 2021, 2022, and 2023 if the plan participant had died on or after the RBD in 2020, 2021, or 2022. The IRS assured taxpayers that final regulations would not take effect before 2023. As 2023 approached, the IRS further extended the relief, excusing missed RMDs for these years.
In April 2024, the IRS extended this relief again, covering RMDs for 2024 from inherited IRAs or defined contribution plans where the account owner passed away between 2020 and 2023 on or after the RBD. Beneficiaries who meet certain requirements will not face penalties for missed RMDs during these years, and plans will not be disqualified solely for these missed distributions.
2024 Final Regulations: What You Need to Know
The final regulations, effective in 2025, require certain beneficiaries to take annual RMDs over the 10 years following the account owner’s death. However, if the deceased had not yet started taking RMDs, the 10-year rule applies differently. Although the account must still be fully depleted within the 10-year period, there is no requirement for annual distributions, allowing for more tax planning opportunities.
For example, consider Ken, who inherited an IRA in 2021 from his father, who had already begun taking RMDs. Due to the IRS-issued waivers, Ken is not required to take RMDs for 2022 through 2024. However, under the final regulations, he must take annual RMDs from 2025 through 2030, ensuring the account is fully distributed by the end of 2031.
If Ken's father had not started taking RMDs, Ken would have had the flexibility to skip distributions from 2025 through 2030, as long as the account was fully liquidated by the end of 2031. This scenario highlights the importance of understanding the specific rules that apply to your situation.
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If you've inherited an IRA or defined contribution plan since 2020, it's natural to have questions about the RMD rules. We can clarify the IRS regulations and recommend strategies that may help you minimize taxes and avoid penalties.
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Bob is an experienced tax professional who devotes his professional time to structuring tax strategies in the areas of compliance, consulting, and planning. Bob works closely with a broad range of high-net-worth individuals and multi-generational families, specializing in the areas of gift and estate planning, charitable gift planning, trust and estate administration, individual taxation, and wealth preservation. Bob serves as a practice leader in the Family Wealth and Estate Planning group. Bob joined Lumsden McCormick in 2008 and was named partner in 2022.