“NEW” RULES IMPLEMENTED ON INHERITED INDIVIDUAL RETIREMENT ACCOUNTS (“IRAs”)
Beginning in 2025, individuals must begin taking withdrawals from IRAs they inherited in 2020 or thereafter. The Internal Revenue Service has finally provided guidance on the implementation of the “ten-year rule” that was part of the Secure Act of 2019 (“Secure Act 1.0”).
The Secure Act 1.0 was enacted to help Americans save for retirement by incorporating changes into the retirement plan rules. There are three notable provisions within the Secure Act 1.0 that significantly impact the rules implemented on IRAs. First, the Act repealed the age limit for making contributions to traditional IRAs and now allows all individuals (regardless of their age) to contribute to a traditional IRA, assuming that they have earned income. Second, the Secure Act 1.0 increased the age for Required Minimum Distributions (“RMDs”) from seventy and one-half (70½) to seventy-two (72) years old. Subsequently, Secure Act 2.0 of 2022 increased the age to 73(it also increased the age for distributions to 75 but not until the year 2033). Third, the Secure Act 1.0 introduced the new “ten-year rule,” which is discussed further in this article.
Certain individuals that inherited an IRA after January 1, 2020, must now withdraw the entire balance of their inherited IRA within a ten (10) year period from the date of inheritance. Prior to 2020, certain individuals were allowed to withdraw these funds over their life expectancy.
One exception to the new ten (10) year rule is an IRA left to an Eligible Designated Beneficiary (“EDB”). A surviving spouse is a member of the EDB category. Thus, a surviving spouse can create a spousal IRA and withdraw the funds over his or her lifetime, which often results in the most significant income tax deferral. Other EDBs include heirs that are born within ten (10) years of the deceased owner, disabled or chronically ill individuals, and minor children of the owner. In the case of minor children (including stepchildren, adopted children and eligible foster children), a total distribution is not required until ten (10) years from the year the child attains age twenty-one (21) years. A disabled beneficiary or chronically ill individual can withdraw an inherited IRA over his or her life expectancy. A disabled or chronically ill individual (for years prior to 2024) must provide the IRA Plan Administrator with documentation, pursuant to I.R.C. Section 7702B. There are deadlines to supply documentation, so individuals are cautioned to review these rules carefully.
The general rules of the Secure Act 1.0 relating to required distributions focus on whether the deceased owner of the IRA was in “pay status,” or in other words, whether the deceased owner was required to take RMDs from the IRA. If the original owner had survived to April 1 of the year following the year in which he or she entered “pay status,” the heirs must take RMD for the year of the owners passing, whether the original owner actually took the RMD or not.
Initially, advisors believed that beneficiaries (except for EDBs) did not need to take distributions in years one through nine. However, in 2022 Regulations of the Internal Revenue Service proclaimed that where “pay status” had begun because the owner was required to take distributions, most beneficiaries needed to take distribution in years one through nine. Because of ambiguities in the statute, this requirement was suspended for 2020 through 2024.[1] This relief has ended and now distributions will be required for 2025. It is interesting to note that the RMD is calculated based on the age of the heir (and not the decedent) by using the single life expectancy tables found on IRS Form 590-B. For example, a fifty (50) year old heir will start at age fifty-one (51) and will use the life expectancy calculation for the next ten (10) years from that point. The balance of the IRA must be distributed completely by the tenth year.
If the deceased IRA owner was not subject to the RMD rules at the time of death, the heir is free to take as much (or as little) of the IRA during years one through nine. However, the entire account still must be liquidated in the tenth year.
[1] See IRS Notice 2024-35.