Understanding the Inherited IRA Rules Under the SECURE Act

Navigating the maze of inherited IRA rules can feel overwhelming, especially with the significant changes introduced by the SECURE Act. Whether you’re an IRA owner or a beneficiary, understanding these new regulations is essential. If you’ve recently inherited a tax-advantaged retirement account—like an IRA or 401(k)—you’ll need to get familiar with what’s called an “inherited IRA.”

The SECURE Act passed in 2020, significantly altered how these accounts are managed, with the biggest impact on non-spousal beneficiaries. While spouses can still roll the IRA into their own or stretch withdrawals over their lifetime, non-spousal beneficiaries now face stricter rules, including the new 10-year distribution requirement. This article will explore what these changes mean for non-spouses and offer guidance for navigating them.

IRS Classification of Beneficiaries

To effectively navigate these new rules, however, it is crucial to understand how the IRS classifies beneficiaries into three main categories:

1. Eligible Designated Beneficiaries: These beneficiaries can stretch distributions over their lifetime and include:

• Spouses
• Minor children of the original account owner (become Non-Eligible Designated Beneficiaries once they turn 21)
• Individuals who are not more than 10 years younger than the original owner
• Disabled or chronically ill individuals

2. Non-Eligible Designated Beneficiaries: These non-spouse beneficiaries must follow the 10-year rule and include:

• Adult children (21 and older)
• Grandchildren
• Siblings who are at least 10 years younger than the original owner.

3. Non-Designated Beneficiaries: These are entities like trusts, estates, or charities.

Key Changes from the SECURE Act for Non-Eligible Designated Beneficiaries

Before the SECURE Act, non-spousal beneficiaries could stretch distributions over their lifetime, reducing tax implications. Now, they must deplete the inherited IRA 10 years after the original owner’s death.

Distribution Rules for Non-Eligible Designated Beneficiaries

If the Account Owner Died Before 2020:

If death occurred before the owner had to take Required Minimum Distributions (RMDs), non-spouse beneficiaries can either:

• Take distributions based on their own life expectancy, starting at the end of the year following the year of death, or
• Follow the five-year rule, requiring them to empty the account by the end of the fifth year after the account holder’s death, with no required withdrawals prior to that.

If death occurred after the owner started RMDs, non-spouse beneficiaries may:

• Take distributions based on the longer of their own life expectancy or the account owner’s remaining life expectancy.

If the Account Owner Died in 2020 or Later:

• If the original IRA owner had not taken RMDs, beneficiaries are not required to make annual withdrawals but must deplete the account by the end of the tenth year following the owner’s death.
• If the owner had begun taking RMDs, beneficiaries must continue taking annual RMDs for the first nineyears and fully withdraw the remaining balance by the end of the tenth year.

IRS Clarifications and Updates

In response to confusion regarding RMD requirements under the new 10-year rule, the IRS issued updated regulations in 2024. Key clarifications include:

• If the owner had started RMDs, beneficiaries must take RMDs for the first nine years and fully deplete the account by the tenth year.
• Additionally, the IRS announced that penalties for missed RMDs between 2021 and 2024 would be waived, allowing beneficiaries more time to adapt to the new rules. Typically, the penalty for missed RMDs is 25 percent of the required amount.
• Penalty waivers do not apply to individuals who inherited an IRA before 2020 and eligible designated beneficiaries or IRA owners who are required to take RMDs.

Planning Considerations

If the beneficiary expects their income to increase, they might take more distributions earlier. Conversely, if their income will be lower in future years (such as during retirement), deferring distributions beyond RMDs if required to take may make sense.

Given the complexity of these new rules, it is crucial to work closely with your tax accountant and financial advisor if you inherit an IRA. They can help you navigate distribution strategies that align with your goals, income, tax bracket, and unique circumstances. If you own a qualified retirement plan, consult your financial team, including your estate attorney, to understand how these changes may impact your beneficiaries.

For those charitably inclined and aged 70.5 or older, consider a qualified charitable distribution (QCD) to reduce taxes on your RMDs. This option is available for both traditional and inherited IRAs, with a limit of $104,000 for 2024. However, keep in mind that this does not satisfy future RMDs if there is still a balance remaining.

As a side note, inheriting a Roth IRA provides opportunities for tax-free growth, requiring full distribution by the end of the tenth year following the owner’s death. One important caveat is that the deceased must have owned the Roth IRA for at least five years for the tax benefits to apply fully.

Conclusion

By understanding the SECURE Act’s impact on inherited IRAs, qualified retirement account owners and beneficiaries can navigate the financial landscape more effectively and make informed decisions.

This content is intended for informational purposes only. While the Financial Advisors at Carter Financial Management do not provide tax or legal counsel, we aim to keep you informed about the latest rule changes.