Retirement planning often includes passing on savings to heirs. For beneficiaries of inherited IRAs, knowing distribution rules is essential to avoid tax burdens and fines. Recent legislation, including the SECURE Act of 2019 and the upcoming SECURE Act 2.0 in 2025, brings notable changes for beneficiaries of IRAs, particularly around required minimum distributions (RMDs) and the timeline for emptying accounts.
Here’s a look at the latest updates and how they impact inherited IRA management.
Ten-Year Withdrawal Rule
The SECURE Act of 2019 introduced a ten-year rule for most beneficiaries inheriting IRAs from 2020 onwards. Under this rule, beneficiaries must empty the inherited IRA within ten years of the original account holder’s death. This change replaced the previous rule, which allowed beneficiaries to “stretch” distributions over their lifetime, significantly reducing annual tax liabilities.
For many, the ten-year rule allowed a more flexible approach, spreading withdrawals over several years. However, the IRS recently clarified that most beneficiaries must take RMDs annually, not just a lump sum by the end of ten years. Starting in 2025, beneficiaries following the ten-year rule will need to withdraw an annual minimum amount, potentially increasing the tax impact year over year.
SECURE Act 2.0
With SECURE Act 2.0, annual RMDs will become a mandatory part of the ten-year rule, starting in 2025. Beneficiaries who fail to take these annual RMDs will face a 25% penalty on the required withdrawal amount, on top of standard income taxes. This penalty, however, can be reduced to 10% if corrected in a timely manner.
Not every inherited IRA account will require annual RMDs. Spouses and eligible designated beneficiaries (EDBs) have different options, which can help them avoid annual withdrawals or minimize taxes.
Special Rules for Spouses
Spouses are often given flexibility with inherited IRAs. If the account holder passes away before their own RMDs have begun, the surviving spouse has a few options:
- Keep the IRA as an Inherited Account: In this case, a spouse can:
- Delay withdrawals until the original account holder would have turned 72.
- Take distributions based on their own life expectancy.
- Follow the ten-year rule for withdrawals.
- Roll Over the IRA to Their Own Account: A spouse can also move the inherited IRA into their own account, allowing them to follow the standard RMD rules as if the funds were their own.
If the account holder passes after beginning their own RMDs, the spouse can:
- Keep the Account as an Inherited IRA: Withdrawals can be taken based on the spouse’s life expectancy, reducing the immediate tax burden.
- Roll Over to a Personal IRA: This provides the spouse with control over withdrawals and aligns the inherited funds with their own retirement timeline.
Eligible Designated Beneficiaries
Certain beneficiaries, classified as eligible designated beneficiaries (EDBs), have options beyond the ten-year rule. EDBs include:
- Spouses
- Minor children of the deceased (until they reach the age of majority)
- Individuals who are disabled or chronically ill
- Beneficiaries who are less than ten years younger than the original IRA owner
These beneficiaries can choose to:
- Take distributions based on their life expectancy or the remaining life expectancy of the deceased.
- Use the ten-year rule if the IRA owner passed away before starting their own RMDs.
This flexibility is beneficial, as EDBs can spread out distributions over a longer period, reducing their tax burden and aligning distributions with their financial needs.
Inherited IRA Rules
The layered rules in SECURE Act 2.0 aim to simplify IRA inheritance but have added complexity. Beneficiaries need to stay informed about annual RMD requirements to avoid penalties and strategize withdrawals for tax efficiency. For those who inherit IRAs, knowing eligibility for spouse or EDB status can make a significant difference in managing taxes on inherited accounts.
With SECURE Act 2.0 approaching in 2025, consult with a tax advisor to navigate these changes and ensure compliance. The right strategy can maximize the benefits of inherited IRAs while minimizing tax impacts, keeping more of your hard-earned legacy intact for your family.
FAQs
What is the ten-year rule for IRAs?
Beneficiaries must withdraw all funds within ten years of the original owner’s death.
Are RMDs required yearly under the ten-year rule?
Yes, annual RMDs are required starting in 2025.
Do spouses have to follow the ten-year rule?
No, spouses have other withdrawal options under IRS guidelines.
Who qualifies as an eligible designated beneficiary?
Spouses, minor children, disabled individuals, and others near the deceased’s age.
Is there a penalty for missing RMDs?
Yes, a 25% penalty applies but can be reduced to 10% with correction.
