The rules surrounding inherited Individual Retirement Accounts (IRAs) have undergone significant changes, thanks to the SECURE Act of 2019 and subsequent updates. These changes are reshaping how beneficiaries can access retirement funds and manage their tax liabilities. If you are a beneficiary of an IRA or managing assets for clients, it’s essential to understand these new regulations and how they might impact your financial planning.
What’s an RMD?
A Required Minimum Distribution (RMD) is the minimum amount that must be withdrawn annually from certain retirement accounts, including traditional IRAs, once the account holder—or in the case of inherited IRAs, the beneficiary—reaches a specific age or inherits the account. RMDs are mandated by the IRS to ensure that retirement funds are eventually taxed rather than left to grow tax-deferred indefinitely.
New Rules for Inherited IRAs
1. The SECURE Act and the 10-Year Rule
Prior to the SECURE Act, those who inherited an IRA through a parent or grandparent could pay taxes and withdraw distributions based on their life expectancies. This became known as a “stretch” IRAs, which were particularly beneficial for younger beneficiaries who could benefit from decades of compounded growth while managing their tax burden due to lower annual distributions. However, the SECURE Act eliminated this option for most non-spouse beneficiaries. Instead, beneficiaries must now deplete the inherited IRA within 10 years of the account holder’s death.
While this rule provides flexibility in terms of when withdrawals can occur within that 10-year period, it significantly alters the tax landscape by accelerating the distribution timeline. As a result, beneficiaries may face a larger tax bill in the years ahead if they have not taken RMDs in prior years, as larger withdrawals could push them into higher tax brackets.
2. Exceptions to the 10-Year Rule
There are some important exceptions to this rule. According to Barron’s, surviving spouses, for example, can still treat the inherited IRA as their own and delay distributions until they reach their required RMD age, which allows continued tax-deferred growth. Minor children of the decedent can take distributions over their lifetime, but once they reach the age of majority, the 10-year rule applies. Additionally, beneficiaries who are chronically ill, disabled, or not more than 10 years younger than the decedent are exempt from the 10-year rule and can continue taking distributions based on their life expectancy.
3. Required Minimum Distributions (RMDs)
According to the Wall Street Journal, while the SECURE Act shifted to a 10-year withdrawal period for most non-spouse beneficiaries, required minimum distributions (RMDs) must begin in 2024 for IRAs inherited in 2020 or later. This means that starting in 2024, non-spouse beneficiaries will have to begin taking annual RMDs based on their life expectancy, which will further increase their taxable income.
4. Tax Implications
These changes bring about significant tax implications. With the 10-year rule in place, beneficiaries may need to make larger withdrawals to meet the requirement, which could push them into higher income tax brackets. Additionally, RMDs will further increase taxable income annually, making it essential for beneficiaries to carefully manage their distributions and tax strategies.
5. Strategic Planning for Beneficiaries
Given the recent changes to inherited IRA rules, it’s more important than ever for beneficiaries to work closely with financial and tax advisors to develop personalized strategies that minimize long-term tax exposure. The timing and size of annual withdrawals are critical, especially for those subject to required minimum distributions (RMDs) or the 10-year distribution rule.
Effective planning may involve spreading withdrawals evenly over the 10-year period to avoid large, lump-sum distributions that could push you into a higher tax bracket. In some cases, it may make sense to coordinate IRA distributions with years of lower income, retirement, or other deductions to help offset the tax burden.
Take the Next Step Toward Confident Financial Planning
At Konza Wealth Group, we offer personalized, professional financial services. Contact us for more information on how these IRA changes may impact your financial future. Understanding them now will allow for better planning and fewer surprises later.
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Konza Global Advisory, LLC in any jurisdiction in which such offer, solicitation, purchase, or sale would be unlawful under the securities laws of such jurisdiction.
Frequently Asked Questions
Who is affected by the 10-year rule?
Most non-spouse beneficiaries are affected, including adult children, grandchildren, and other non-qualified individuals. This rule accelerates the distribution schedule and may increase annual tax liability.
Do I have to take RMDs during the 10-year period?
It depends. If the original IRA owner had already started RMDs before their death, annual RMDs may be required for the beneficiary during the 10-year period. If not, the account still must be fully distributed by the end of the 10th year.
What happens if I don’t take the required RMDs?
Failing to take an RMD can result in a 25% penalty on the amount that should have been withdrawn. It’s essential to understand and follow the updated IRS guidelines to avoid unnecessary costs.
The information contained in this writing should not be construed as financial or investment advice on any subject matter. Konza Global Advisory, LLC expressly disclaims all liability regarding actions taken based on any or all the information in this writing.
