Beneficiaries need to understand that the rules and requirements surrounding inherited Individual Retirement Accounts (IRAs) can be complex, especially when it comes to required minimum distributions (RMDs). The passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act in 2019, followed by the SECURE 2.0 Act in 2022, has brought significant changes to the distribution rules for inherited IRAs. Failing to comprehend these requirements can result in missed tax planning opportunities and potential penalties.
The SECURE Act introduced a rule that requires most non-spouse beneficiaries who inherit IRA assets on or after January 1, 2020, to withdraw the full balance within 10 years. This change eliminates the previous “stretch” IRA tax planning strategy, which allowed beneficiaries to distribute inherited IRAs over their lifetime.
The original rules for RMDs under Sec. 401(a)(9) still form the basis for many distribution requirements. These rules apply to various defined contribution plans, including regular and Roth IRA accounts, annuity contracts, custodial accounts, profit-sharing, Sec. 401(k), and Sec. 403(b) accounts, as well as Sec. 457(d) deferred compensation accounts.
Sec. 401(a)(9)(B)(i) addresses distributions if the IRA owner dies after RMDs have started. In this case, the remaining interest in the account must be distributed at a rate that is at least as rapid as when the owner was alive. If the IRA owner dies before RMDs have begun, Sec. 401(a)(9)(B)(ii) requires the account to be distributed within five years after the owner’s death. However, the SECURE Act modified this requirement.
The SECURE Act introduced Sec. 401(a)(9)(H), which extends the required distribution period from five years to 10 years for beneficiaries of owners who die after December 31, 2019. This rule applies to all designated beneficiaries, regardless of whether the decedent had started RMDs. Additionally, the concept of an “eligible designated beneficiary” was introduced, allowing certain individuals to use the life expectancy payout method.
The five types of eligible designated beneficiaries include the surviving spouse, children who are younger than the age of majority, disabled individuals, chronically ill individuals, and individuals not more than 10 years younger than the deceased IRA owner. Each type has specific rules regarding RMDs and distribution timelines.
It is crucial to determine the beneficiary’s relationship to the account owner and the owner’s age at the time of death to understand the distribution options. Spouses have more flexibility in their distribution choices, while non-spouse beneficiaries may have different rules based on their circumstances and the presence of other beneficiaries. The beneficiary designation can also be changed with proper planning.
Knowing when to begin RMDs is essential, as the SECURE Act accelerated distribution requirements. Failure to start RMDs on time can result in excise taxes. Spouses can choose to treat the account as their own, and non-spouses must take RMDs immediately and empty the account within 10 years, unless they meet specific exceptions.
Effective dates and transition rules have caused confusion among advisers, but IRS guidance has clarified the requirements. Interim guidance and forthcoming final regulations clarify that RMDs must begin in the first calendar year after the IRA owner’s death if they had reached their required beginning date. The remaining balance must be distributed by the 10th calendar year after the owner’s death.
For those who missed RMDs, relief is available. The excise tax for missed distributions has been reduced to 25% in 2023 and can be further reduced to 10% if corrected in a timely manner.
Fee-only professionals, including financial advisers, can play a crucial role in helping individuals with their financial planning needs. These professionals have a fiduciary duty to act in their clients’ best interests, which means their advice is unbiased and solely focused on helping clients achieve their financial goals. They can provide a comprehensive analysis of an individual’s financial situation, develop a customized financial plan, and offer ongoing guidance to ensure that the plan stays on track. Whether it’s creating a retirement savings strategy, managing investments, or navigating tax implications, fee-only professionals can provide the expertise and guidance needed to make the most of one’s financial resources.
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