Starting in 2025, certain non-spouse beneficiaries of inherited IRAs and other inherited qualified retirement accounts will be required to take a Required Minimum Distribution (RMD). This requirement is in addition to fully depleting accounts under the “10-year rule.”
Secure Act Rules Refresher
The Secure Act, which was enacted in December 2019, introduced significant changes to the distribution requirements for inherited qualified retirement accounts. These changes apply to accounts inherited on or after January 1, 2020, including IRAs, 401(k)s, and 403(b)s (referred to as “inherited accounts”).
One of the most significant updates brought about by the Secure Act is the introduction of the ’10-year rule’ for accounts inherited by non-eligible designated beneficiaries. This rule mandates that inherited accounts be fully distributed by December 31 of the tenth year following the year in which the original account owner passed away.
On the other hand, eligible designated beneficiaries can still stretch their distributions over their life expectancies, with additional flexibility provided for surviving spouses. The remainder of this article will focus specifically on non-eligible designated beneficiaries.
Initially, under the Secure Act, it was believed that non-eligible designated beneficiaries were only bound by the 10-year withdrawal rule. However, in 2022, the IRS proposed a different interpretation, suggesting that specific beneficiaries must also take annual Required Minimum Distributions (RMDs).
In July 2024, the IRS finalized those proposed regulations and answered the big question:
Do I need to take annual RMDs?
- Yes – if the original account owner (decedent) reached their required beginning date
- No – if the original account owner (decedent) had not yet reached their required beginning date
The required beginning date for taking required minimum distributions (RMDs) is based on the age of the original account owner. If the deceased had started RMDs, the beneficiary must continue taking RMDs and fully distribute the account within 10 years.
Starting January 1, 2025, non-eligible designated beneficiaries must take their first RMD that year without making up missed distributions from prior years. The IRS has waived penalties for previously missed distributions.
It’s important to note that the finalization of these rules does not reset the 10-year distribution period. For instance, a beneficiary who inherited an IRA in 2020 must still fully distribute the account by December 31, 2030.
Roth Accounts Inherited by Non-Eligible Designated Beneficiaries
The 10-year rule applies to pre-tax (traditional) and Roth retirement accounts inherited by non-eligible designated beneficiaries. A nuance arises concerning the annual RMD rules. Inherited Roth IRAs, specifically, do not have annual RMD requirements. Inherited Roth 401k(s) and 403(b)s are more complex. In the latter cases, RMDs are not required by beneficiaries if the decedent (1) passed before their required beginning date or (2) only had a balance in the Roth portion of the plan (no balance in the pre-tax portion). Otherwise, if the decedent had balances in both pre-tax and Roth portions of the plan along with having passed after their required beginning date, both the pre-tax and Roth 401(k)/403(b) are subject to RMDs by the beneficiaries. This nuance benefits rolling over Roth 401(k) or 403(b) balances to a Roth IRA. Also, it is essential to note that Roth IRA distributions are tax-free if the account meets the five-year rule. This rule applies from the original owner’s first Roth IRA contribution date.
Strategic Planning
At Martin Strategic Wealth, we’re all about strategic planning. Maximizing after-tax benefits requires careful planning for beneficiaries with inherited retirement accounts under the new RMD and 10-year rules. Provided below are some considerations:
- Some situations may require withdrawing more than the Required Minimum Distribution (RMD) each year. For example, a beneficiary who only needs to follow the 10-year rule (which does not require annual RMDs) might benefit from taking distributions earlier or even on an annual basis. In other cases, it may be better to take only the minimum required or to delay distributions, effectively postponing tax implications. The best outcomes are often achieved through a careful review of an individual’s current and expected future tax circumstances, as well as the specific details of the account.
- It is crucial for retirement account owners to start planning strategically for their future heirs and consider the assets they wish to transfer. This is especially important for those with large pre-tax (traditional) balances. Frequently, beneficiaries are in their highest earning years when they inherit these assets, and new regulations restrict their options for tax optimization. As a result, the opportunities to review Roth conversions have gained even greater significance.
- It’s also wise to conduct an annual review of your IRA beneficiaries. For instance, consider whether it makes sense to add contingent beneficiaries, as this can provide more options after your passing. You might even want to include a charitable beneficiary as part of your plan. Therefore, it’s important to regularly review your current beneficiaries and future giving plans to identify effective resources to utilize.
Understanding inherited IRAs can seem challenging, especially with recent changes in regulations. These updates affect both current account holders and those preparing for their beneficiaries. If you have any questions about how these rules may impact you, our friendly advisors are here to assist! We can work together to create a tailored strategy that minimizes taxes and enhances the advantages of your inherited IRA. Let’s navigate this journey together!
