Investors who have inherited an IRA from a parent, grandparent, or another non-spouse investor prior to 2020, could choose to take required minimum distributions over their lifetime, calculated using the IRS Single Life Expectancy table and the account balance. For a young beneficiary, a longer payout period allowed for smaller annual distributions and many more years of tax-deferred growth.
As we often caution investors, tax rules are subject to change, and indeed, they have! Because of changes associated with the SECURE Act of 2019, all non-spousal beneficiaries are now required to deplete the account within 10 years of any decedent who has passed away after 2019. Remember, Congress creates tax laws through the Internal Revenue Code, but it is the IRS that interprets how the law applies to various situations. When the Act first passed, annual required minimum distributions were not mandatory; the only rule was that the Inherited IRA account balance needed to be withdrawn by the 10th year. In May 2021, IRS Publication 590-B reflected this original assumption.
The SECURE Act also introduced “eligible designated beneficiaries,” defined as a spouse, a minor child of the deceased, a disabled person, a chronically ill individual, or an individual not more than 10 years younger than the retirement account owner, who were generally exempt from the 10-year rule.
For beneficiaries in their 30s or 40s, this new 10-year rule could potentially push them into a higher tax bracket due to the additional income from a withdrawal. Depending on the individual’s situation, financial advisers may have recommended taking smaller withdrawals over several years to spread out the tax due; taking advantage of a low-tax year that would offset the inheritance income, or, in some cases, the recommendation was to wait until the 10th year to withdraw all the money from the account.
In February 2022, the IRS issued guidance under proposed regulations, indicating that beneficiaries of inherited IRAs were required to continue taking RMDs over the 10-year required pay-out period on an annual basis if the original owner had already begun taking RMDs during their lifetime. As many taxpayers had not interpreted the rules this way, the IRS issued a notice in October 2022 that provided relief from the 50% penalty if required distributions were not withdrawn in 2021 and 2022.
The SECURE 2.0 Act, passed in late 2022, also initiated changes to the RMD age for account owners, with implications extending to those who inherited IRAs from owners who may or may not have been required to take RMDs.
Finally, in July 2023, IRS Notice 2023-54 provided relief to beneficiaries who were supposed to take RMDs from inherited IRAs in 2020, 2021, 2022, and 2023, with the implementation of final regulations set to be effective in 2024. Unfortunately, questions remain unanswered on whether beneficiaries subject to RMDs will be required to catch up on skipped RMDs.
With so many moving parts, we highly recommend consulting with a financial adviser and tax adviser if you inherited an IRA after 2020. The penalty for not fulfilling a required minimum distribution is 25% of the amount not withdrawn. While this is less than the previous penalty of 50%, it still represents a significant reduction in your inheritance.
If you have questions on how to handle an inherited IRA, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
Listen to the October 7, 2023 “Henssler Money Talks” episode.
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