IRS Finally Clarifies New Rules for Beneficiaries of Inherited IRAs

Back in December 2019, Congress passed significant changes to retirement account rules, known as the SECURE Act. Among other provisions, the SECURE Act stipulated that certain non-spouse beneficiaries who inherited an IRA from a deceased loved one would now be subject to a 10-year rule: Instead of being allowed to stretch the taxable distributions from an Inherited IRA across his or her lifetime, the beneficiary would need to withdraw the full account balance by the end of the 10th year after the year that the original account owner passed away.

The language of the SECURE Act was unclear, however, on whether non-spouse beneficiaries subject to the 10-year rule would need to take annual required minimum distributions (RMDs) from the Inherited IRA during that timeframe or could wait, for example, until the end of the 10-year period to take all of the distributions. (Being able to take distributions at any point in the 10-year period is preferable from a planning perspective because you can defer taxes longer and/or concentrate the withdrawals in years when the beneficiary is in a relatively low tax bracket. For example, if the beneficiary was planning to retire during the 10-year period, you could wait to take withdrawals from the Inherited IRA until his or her taxable income dropped at retirement.)

After years of punting this question, the IRS has finally given us an answer: some beneficiaries of Inherited IRAs do need to take RMDs during the 10-year period, and some do not. (Ha! Thanks a lot, IRS!)

Four Types of Beneficiaries. The IRS regulations have established a regretfully complicated maze of options, but we will outline here the main types of IRA beneficiaries and how the new rules affect each of them.

• Spouse Beneficiaries: Beneficiaries who were married to the deceased account owner are not affected by this recent rule change. Spouses have a myriad of options for inherited IRA assets, which are generally preferable to those for non-spouse beneficiaries from a tax management perspective. For example, they can transfer the inherited IRA assets into their own IRA, or they can establish an Inherited IRA and stretch distributions from it over their lifetimes. The latter option is also available to certain other “Eligible Designated Beneficiaries,” such as non-spouse beneficiaries who are: disabled, chronically ill, less than 10 years younger than the account owner, or a minor child of the account owner.
  • Calculating Beneficiary RMDs. Similar to the rules for original account owners, the RMD for an IRA beneficiary in the year after the account owner’s death is calculated by taking the prior year-end account balance and dividing that amount by a life expectancy factor. (Beneficiaries typically use the Single Life table for life expectancy factors.) In subsequent years, beneficiaries reduce the original life expectancy factor by 1 and divide the prior year-end account balance by that number.
• Non-spouse Beneficiaries of IRAs Whose Owner Passed Away before 2020: This category of beneficiaries is also not affected by the recent rule change. Similar to the rules for “Eligible Designated Beneficiaries,” non-spouse beneficiaries who inherited IRA assets prior to 2020 can open an Inherited IRA and stretch distributions from it over their lifetimes (taking only the RMD in a particular year, unless they want to withdraw more).
• Non-spouse Beneficiaries of IRA Owners Who Passed Away after 2019 and Had Not Yet Started Taking RMDs: Per the recent clarification from the IRS, non-spouse beneficiaries who inherited IRA assets after 2019 can withdraw assets from the Inherited IRA at any point during the 10-year period starting the year after the account owner’s death, provided that the account owner died before starting to take RMDs. These non-spouse beneficiaries are not subject to any RMDs on an annual basis during the 10-year timeframe.
• Non-spouse Beneficiaries of IRA Owners Who Passed Away after 2019 and Had Already Started Taking RMDs: By contrast, if the original account owner died after starting to take RMDs, the non-spouse beneficiary is subject to RMDs starting the year after death and also must withdraw all of the assets from the Inherited IRA by the end of the 10-year period starting the year after the account owner’s death.
  • Roth Accounts. This rule does not apply, however, to this category of non-spouse beneficiaries if 100% of the account balance was in a Roth account, such as a Roth IRA or a Roth 401k. In that case, the beneficiary only needs to withdraw all assets from the Inherited Roth IRA by the end of the 10-year period and does not need to take RMDs during that timeframe.
  • Determining RMD Age. Whether or not the account owner had started taking RMDs during his or her lifetime depends on his or her age at date of death. Starting in 2020, the starting ages for RMDs were as follows:
    • Age 72 for those born in 1950 or earlier
    • Age 73 for those born in 1951-1959
    • Age 75 for those born in 1960 or later

While the above guidelines may seem complicated, this is really just a brief overview of the key rules surrounding Inherited IRAs, so if you have questions regarding the details or logistics of required distributions as an IRA beneficiary, please do not hesitate to call or email us any time.