Changes to the rules brought about by the SECURE Act enacted in December of 2019 and subsequent Proposed Regulations concerning the timing of required distributions from inherited IRA’s lacked specific guidance for the situations of many taxpayers. At last, after a long period of uncertainty, Final Regulations have been issued that update these rules.
One of the more monumental changes of the SECURE Act was to eliminate the prior “stretch” treatment of post-death distributions for most non-spouse beneficiaries and replaced that treatment with the “10-Year Rule” which requires beneficiaries to fully distribute inherited retirement accounts by the end of the 10th year following the original account owner’s death.
In early 2022, with the issuance of Initial Proposed Regulations regarding the SECURE Act’s provisions, ineligible designated beneficiaries (described below) were not only subject to the 10-Year Rule, but, if the original account owner had been subject to Required Minimum Distributions (RMDs) prior to their death, the beneficiary would also need to take annual RMDs throughout that 10-year period in addition to distributing all assets in the account by the end of the 10th year. These proposed regulations still left much to be desired in concrete guidance regarding the timing of required distributions and possible penalties imposed for not doing so.
Now, with the July 18, 2024 issuance of the Final Regulations on the topic, the IRS confirms that Ineligible Beneficiaries are required to take RMDs annually. On a positive note, for beneficiaries who would have been required to take RMDs in 2021–2024 but did not, the IRS has confirmed that there will be no penalty and no requirement to make up the missed distribution, meaning the new regulation effectively starts with RMDs required to be taken in 2025. The Final Regulations, as issued, are not a change to existing rules, but are a clarification to the requirements Congress passed in the Secure and Secure 2.0 law. The regulation distinguishes between instances in which the original participant began taking RMDs before they died and instances when they died before they started taking RMDs. It also differentiates between eligible designated beneficiaries and designated beneficiaries. Here is a brief outline of what we know now:
- Eligible Beneficiaries (a participant’s spouse, someone disabled or chronically ill or another beneficiary not more than 10 years younger, such as a younger sibling)
a. The 10-Year rule is not mandatory but can be elected for this class of beneficiaries.
b. If the deceased account owner had not already begun taking RMDs, then an eligible beneficiary can either choose to take RMDs consistent with their life expectancy or elect the 10-year rule.
c. If the deceased account owner died after beginning to take RMDs, then the beneficiary can take RMDs consistent with the longer of their life expectancy or that of the original owner. - Ineligible Beneficiaries (most beneficiaries not listed above).
a. The 10-year rule is mandatory for ineligible beneficiaries.
b. A partial exception from the 10-year rule is made for heirs younger than 21: Their 10-year clock does not start until they turn 21. At age 21, the beneficiary will have to take RMDs every year consistent with their life expectancy, which will tend to yield smaller amounts, and must distribute out the total account by the end of 10 years.
c. When the participant has begun taking RMDs, the beneficiary must take RMDs “at least as rapidly” as the participant had been. In the event there are assets remaining at the end of 10 years, the remaining balance must be completely distributed.
d. If the initial owner was not yet required to take an RMD, then the ineligible beneficiary does not need to take RMDs and can choose to simply withdraw the entire balance at the end of 10 years. There is an important tax planning opportunity available with this choice.
e. The IRS provided transitional relief that postponed the RMD requirement prior to 2025. The final regulations make it clear that that this transitional relief did not extend the 10-year deadline. This means, for example, that accounts inherited from a decedent who passed away in 2020 must be fully distributed prior to 2031.
As happens with most tax law changes, there are a number of nuances and exceptions to the Secure Act rules pertaining to withdrawals from inherited retired accounts that will make it advantageous to work with a financial advisor or tax planner who can explain and apply these rules to your individual tax situation. With the possible expiration at the end of 2025 of the lower tax rates enacted by the Tax Cuts and Jobs Act, timing of withdrawals could become very important to take advantage of the lowest possible marginal tax rates. The investment managers, tax preparers and planners working as a team at Baldwin Management, LLC are ready to assist you in these decisions.
Eric T. Meck , Managing Director, CFO & Family Office Controller
Eric Meck has more than thirty years of family office accounting and tax experience. He handles all aspects of individual, family, corporation and foundation financial matters. Eric holds a B.S. in Accounting from Kutztown University and is a member of the Institute of Certified Management Accountants, the National Association of Tax Professionals and National Society of Tax Professionals.