Finally! Final Regulations for Inherited IRAs

In December 2019, the SECURE Act was passed, upending how IRA beneficiaries distribute their inheritance. Confusion quickly spread among inheritors and across the wealth management industry—are Required Minimum Distributions needed or not? After many years in limbo, the IRS finally released Final Regulations clarifying the important provisions.

Four Years of Uncertainty

Before the SECURE Act, one might have said that inherited IRAs were fairly simple. A widow who inherits their spouse’s IRA can roll the balance into their account and take Required Minimum Distributions (RMDs) according to their life expectancy, beginning at their own Required Beginning Date (RBD). Non-spousal inheritors could keep the balance in an inherited account and take RMDs based on their life expectancy. This rule allowed non-spouse beneficiaries to “stretch” distributions throughout their lifetime.

When the SECURE Act passed, the spousal rules remained in place; however, most non-spousal beneficiaries were now faced with a 10-year window to draw the account down to a zero-dollar balance. The part that remained unclear was whether or not non-spousal beneficiaries must take Required Minimum Distributions during the 10 years.

In theory, if distributions are not required, a beneficiary could let the account grow tax-deferred for 9 years and take a total withdrawal in the final year, delaying the income tax owed. For the sake of simplicity, this article primarily applies to non-spousal beneficiaries.

The New Rules

The IRS published the long-awaited Final Regulations for the SECURE Act inherited IRA provisions in July. Beginning January 1, 2025, most non-spousal beneficiaries must take an RMD from their inherited IRA if the decedent is of RMD age. The caveat is that these rules are retroactively applied to accounts inherited in 2020 and beyond when the SECURE Act took effect.

From 2020 through 2022, the Required Beginning Date for RMDs was age 72. In 2023, the RBD increased to age 73; in 2033, it will increase to 75! So, if a decedent passes at 72 in 2024, a non-spousal beneficiary would not have to take RMDs during the 10-year period. It’s important to remember the rule changes and important dates when evaluating each situation.

Required Minimum Distributions are based on the longer life expectancy between the deceased person and the beneficiary. In many cases, the non-spousal beneficiary will be younger, in which case the RMD is calculated by taking the end-of-year balance from the prior year and dividing it by the RMD factor from the IRS’ single life expectancy table.

Let’s look at an example: Susan inherited an IRA from her father this year with a 2024 end-of-year balance of $500,000. Next year, Susan turns 50, and her dad passes at 75. With a life expectancy factor of 36.2, her 2025 RMD is $13,813. In this example, you’ll notice that the RMDs are not likely to deplete the account in 10 years, so it’s important to consider how to spread the tax liability across the 10-year timeframe.

Interestingly, the IRS decided that inheritors of Roth IRAs are never subject to RMDs. Thus, the account only needs to be depleted by the 10th year.

However, a Roth 401k does not necessarily get the same treatment. If a Roth 401k holds a single pre-tax dollar, then the pre-tax portion is subject to RMDs. A “tainted” Roth 401k is not uncommon, as most employer contributions are made pre-tax. This makes a strong case for rolling Roth 401k dollars into a Roth IRA when one separates from service.

Message to IRA Owners and Beneficiaries

For IRA or 401k owners who intend to pass assets on to a non-spouse, review your estate plan wishes and the financial situation of your beneficiaries. Sometimes, passing IRA dollars on to a low-earning beneficiary and Roth or brokerage assets onto a higher-earning beneficiary can make sense.

If you’re a non-spousal beneficiary of an IRA, it’s important to understand that these rules apply only to IRAs inherited in 2020 and beyond. The RMD rule doesn’t begin until 2025, and no make-up RMDs must be taken for years before 2025.

Just because an RMD is required doesn’t mean that’s all you should take out for the year. It’s essential to have a strategy for drawing down the account, or you may end up with a substantial tax bill in year 10.

Conclusion

Since the SECURE Act became law, Inherited IRAs have become exceedingly more complicated. The Final Regulations from the IRS only amplify the difficulty. Partnering with a tax preparer and/or financial advisor who stays informed on the rules is more important now than ever.

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