After much anticipation, the Treasury Department and the Internal Revenue Service (IRS) have issued final regulations relating to the RMD rules (required minimum distribution) for people who inherit individual retirement account (IRA) assets.
The newly published guidelines generally reflect what the IRS proposed in 2022, but they bring clarity to several key questions about the rule, which mandates that certain retirement account beneficiaries fully distribute those accounts within a decade of the original account holder’s death.
Regulators have confirmed that most beneficiaries must continue to take RMDs annually throughout the 10 years and fully withdraw the account by the end of the 10th year. As with any tax law change, however, there are exceptions and nuances to the rules that can cause confusion.
Background on the New Rule
The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 made several significant changes related to retirement account RMDs. Additional RMD changes were made in the SECURE 2.0 Act of 2022. These changes have implications not only for account owner RMDs, but also RMDs for retirement account beneficiaries.
Prior to 2020, designated beneficiaries who inherited IRAs, 401(k)s, and other pre-tax contribution plans could withdraw the funds over the course of their lifetime. This allowed for smaller, longer distributions as well as less taxable income and more time to accumulate gains. It was the basis of the so-called “stretch IRA,” an estate planning strategy commonly used with traditional IRAs.
But under the SECURE Act, for dates of death starting January 1, 2020, the general rule is that funds from an inherited retirement account passed to a designated beneficiary must be distributed within 10 years of the original account holder’s death. There are several exceptions to the 10-year rule, however. It doesn’t apply to:
- A surviving spouse
- Minor children of the original account holder who have not reached the age of 21
- Someone who is disabled or chronically ill (as determined in the regulations)
- An individual who is not more than 10 years younger than the account owner
These eligible designated beneficiaries can still qualify for lifetime stretch.
However, it wasn’t clear in the original language of the law whether typical designated beneficiaries had to take RMDs over the course of 10 years or whether they could wait until the 10th year to withdraw the full amount.
Main Takeaways From the Final RMD Rules
The IRS states in a related release that the final regulations generally follow the proposed regulations from 2022.
Crucially, the final regulations answer one of the top questions people have been asking about the 10-year rule: Are RMDs required annually during the 10-year payout period, or does the account simply have to be fully distributed within 10 years? The answer depends on whether the account owner died before or after their RMD start date:
- If the original owner dies before their RMD start date, beneficiaries (who are not eligible designated beneficiaries) do not have to take annual RMDs.
- If the original owner died on or after their RMD start date, RMDs must be paid to the beneficiary over the 10-year period, starting the year after the owner dies.
Due to a series of IRS notices that waived beneficiary RMDs from 2021 to 2024, the 10-year rule does not take effect until 2025. But as noted, if the original account holder had already started RMDs, all money must be out of the account within the 10-year window, regardless of the specifics.
Tax and Estate Planning Strategies for Inherited Retirement Accounts
Despite these complications, there are some taxpayer wins in the final regulations. For one, the separate account rules for inherited IRAs now apply to trusts. This means that, in practice, a single trust can be named on the account beneficiary form along with other beneficiaries, like a spouse and adult child. As long as the trust splits immediately into sub-trusts, each sub-trust beneficiary can apply its own post-death RMD rules. So can any other beneficiaries.
For many, retirement accounts comprise a significant portion of the assets they wish to leave to their beneficiaries. These new rules emphasize the important of integrating your retirement account planning into your overall estate plan. Here are a few of the planning considerations for retirement account planning:
- Spouse beneficiaries have the option to treat the IRA as their own. If a spouse inherits a traditional IRA, and their deceased spouse was not taking RMDs, the surviving spouse can wait until reaching their RMD age to begin making withdrawals.
- The ability for disabled and chronically ill beneficiaries to maintain lifetime stretch (where typical beneficiaries cannot) provides an opportunity to prioritize retirement accounts to be directed to those with special needs where favorable tax treatment can be ensured.
- Irrespective of who is inheriting the IRA, the heir must take the RMD for the year the account owner died by December 31.
- Retirement account withdrawals are typically treated as taxable income, so beneficiaries should think about how much they want to withdraw each year. It might make more sense to take equal installments over 10 years, rather than taking it all out in the 10th year.
- Roth IRA beneficiaries needn’t take annual RMDs over 10 years, and Roth beneficiaries are generally not taxed on distributions.
Retirement account considerations and the new RMD rules are an essential part of a comprehensive estate plan. The estate planning attorneys at Kurre Schneps can help you integrate your retirement accounts into your estate plan. Contact us today.
