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5 Things to Know about New Inherited IRA Rules

5 Things to Know about New Inherited IRA Rules

Over the last 5 years, the landscape of retirement accounts has changed drastically with the December 2019 SECURE Act and the December 2022 SECURE 2.0 Act. Of all the things Congress cannot agree on, retirement planning is not one of them with both bills passing almost unanimously.

While there were several positive things for retirees, one of the biggest negatives in the initial SECURE Act was the change in how retiree’s loved ones have to distribute inherited IRAs. As a reminder, the 2019 SECURE Act eliminated the ‘stretch’ IRA (where beneficiaries could “stretch” out their required distributions over their lifetime) and replaced it with the new 10-year rule.

And believe it or not, the government is still issuing updates to a law that was passed almost 5 years ago. While Congress passes the law, it is up to IRS to regulate it. In this case, the IRS just announced its Final Regulations for the December 2019 SECURE Act on July 18th, 2024. The Final Regulations outline how the IRS will ‘interpret’ the law that Congress passed. Please keep in mind that the Final Regulations was 260 pages so there is a TON of nuance here, what I’m presenting in the following bullets is how it will affect most people who inherit IRAs.

Here are the 5 things you need to know about the Final Regulations:

  1. For most non-spouse beneficiaries, an inherited IRA needs to be fully distributed within 10 years AND if the decedent had already started taking their required distributions (RMDs), then the beneficiary needs to take a RMD in years 1-9 as well.

    When the SECURE Act first passed, most thought an inherited IRA just needed to be fully liquidated by 12/31 of the 10th year after death; however, the final regulations make it clear that RMDs will be required as well.

    For example, let’s say we have a decedent who passed away at age 65 and left their IRA to their 35- & 30-year-old daughters. Since the decedent had not yet started their own RMDs, the daughters do not have to take RMDs years 1-9. The only required distribution is that their inherited IRA accounts are fully liquidated at the end of the 10th year.

    On the other hand, let’s say the decedent in the above example was 75, therefore they had already begun their RMDs. When their daughters inherit their IRAs, they will have to take RMDs based upon their life expectancies in years 1-9 AND the accounts must be fully liquidated by the end of the 10th year.

    Lastly, please keep in mind that Roth IRAs do NOT have RMDs. When a non-spouse beneficiary inherits a Roth IRA, the account must simply be liquidated by the end of the 10th year. No RMDs are required in years 1-9.
  1. The IRS has waived the missed-RMD penalty for all post-SECURE Act beneficiaries who have not yet taken an RMD from their inherited IRA. Remember that RMDs exist so the IRS and the government have more tax revenue, so when a taxpayer does not take a required distribution, the IRS imposes a hefty 25% tax penalty on the missed distribution. Since those who inherited IRAs in 2020 – 2024 did not know that a RMD was required (since these final regulations were just issued in July this year), the IRS has waived the RMD and therefore the penalty. Penalties will begin to be assessed again for those who miss their RMD on an inherited IRA for tax year 2025.
  1. The IRS now allows flexibility in how a decedent’s undistributed year-of-death RMD is satisfied. It is common that retirees tend to wait until the end of the year to take their full RMD or they take it pro-rata over the year. When a decedent passes away before taking the full year RMD, the IRS expects someone to complete that RMD (again, it’s all about that tax revenue). As part of the Final Regulations the IRS now allows beneficiaries to choose who will complete the RMD.

    For example, let’s say our 75-year-old decedent from earlier had a $50,000 annual RMD and had only taken $30,000 of that RMD before passing away. The beneficiaries, the decedent’s two daughters, can choose how to split up the remaining $20,000 RMD from their inherited IRAs. Daughter 1 could choose to take the full $20,000, they could split it $10,000 each, or any other combination, as long as the full $20,000 is distributed.

    There is one nuance to the Final Regulations I’ll mention, if you are someone who has multiple pre-tax IRAs and you have different beneficiaries on each of your IRAs, there is a separate rule for that, and you should seek advice to understand the new rules.
  1. The IRS has extended the amount of time a beneficiary has to complete a decedent’s year-of-death RMD until 12/31 the following year.

    Death happens all the time, January 1st through December 31st. To make the lives of beneficiaries a little easier during a difficult time, the IRS has extended the amount of time a beneficiary has to complete the decedent’s year-of-death RMD. As anyone knows who has gone through the process, obtaining a death certificate, the custodian processing the death and opening inherited IRAs, transferring the assets between accounts, and setting up distributions for the beneficiaries can take time.

    Using the above example, let’s say a decedent passed away on December 15th. Their two daughters will have until 12/31 the following year, a little over a year, to complete the $20,000 undistributed RMD.
  1. The IRS clarified the rules for successor beneficiaries, meaning the beneficiary of a beneficiary. You might wonder, does that really happen? In my experience it absolutely does, and I have an example below.

    Before we get to the example, there are two main situations to address:
    1. If the original beneficiary was stretching RMDs over their lifetime the successor beneficiary must use the 10-year rule.
    2. If the original beneficiary was already subject to the 10-year rule, then the successor beneficiary will step into the shoes of the original beneficiary upon their death and complete their 10-year clock.

A recent example was two daughters who inherited IRA assets from their deceased mother and then one of the daughters passed away leaving the inherited IRA to her sister. So, the question was, how does the surviving sister treat the inherited IRA from her sister’s inherited IRA?!

In this case, the mother passed away before January 1st, 2020, so the sisters were allowed to stretch the RMDs over their lifetime. However, when the sister passed away it was after 2020. Therefore, the surviving sister has 2 inherited IRAs with different distribution rules even though they both originated from her mother! The surviving sister’s inherited IRA from her mother can continue to use the stretch taking RMDs over her lifetime but the inherited IRA from her deceased sister will be subject to the 10-year rule.

As I mentioned, these are just the rules that will apply to most people. Within the 260 pages of the Final Regulations are many more one-off rules and I didn’t even mention the 36 pages of proposed rules around the SECURE 2.0 Act. If you are worried about making a mistake as you navigate retirement, your inheritance, or making sure your legacy is compliant with the everchanging landscape of retirement accounts, please feel free to reach out to us at 219-465-6924.

Mark Rosinski, CFP®, CPA

Wealth Advisor

Please note that this blog is for educational purposes only and Kotys Wealth Professionals does not prepare taxes. Always consult your accountant about your personal tax situation.

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