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The passing of the 2019 Secure Act changed the rules about when non-spouse beneficiaries must begin taking money from inherited retirement accounts. Starting in 2020, instead of stretching withdrawals over your lifetime, most investors inheriting an IRA from a parent were subject to a new “10 year rule.” This meant annual required minimum distributions (RMDs) were out. Instead, beneficiaries had to take the money – in full – in 10 years. In early 2022, the IRS proposed new changes, and if enacted, some inherited IRA beneficiaries will need to take RMDs again and could face big penalties.
IRS proposes changes to Secure Act inherited IRA RMD rules
Unless a non-spouse beneficiary qualifies for an exception¹, previous guidance stipulated that funds from an inherited 401(k), IRA, 403(b), or other qualified retirement plan (including Roth IRAs) must be taken in 10 years following the year of death. Original guidance indicated disbursements within this 10-year window were optional.
Now, proposed regulations from the IRS further complicates the matter by changing previous guidance. For some, this comes years after the death took place.
Changes that would affect individuals who inherited an IRA from a parent
The central change the IRS is proposing would impact beneficiaries who inherited an IRA from a non-spouse who were subject to RMDs on the date of death and passed away after 12/31/2019.
Another key aspect that the 2019 Secure Act changed was the required minimum distribution age. Individuals born before July 1, 1949 will retain an RMD age of 70 1/2. People born on or after this date saw their required beginning date increase to age 72.
The new IRS proposal would require individuals who inherited a retirement account from decedents meeting this criteria to take RMDs during this 10-year period and fully disburse funds by the end of 10 years. Withdrawals during years one through nine would use the old stretch IRA rules.²
Assuming the changes pass, some beneficiaries will have missed a required distribution. Typically, the penalty for such a mistake is 50% of the missed RMD! It’s probable that the IRS would waive penalties as the announcement only came in February 2022 and still isn’t law. So beneficiaries who should have taken a RMD in 2021 wouldn’t have had any opportunity to do so.
What the IRS proposal wouldn’t change
The new guidelines currently wouldn’t alter existing post-Secure Act guidance for beneficiaries who inherited a retirement account from a non-spouse who died before reaching their RMD age. Changes wouldn’t apply to individuals who died (at any age) before 2020 or between spouses.
The new guidance also wouldn’t apply to beneficiaries of Roth IRAs, as Roth IRAs don’t have RMDs (Roth 401(k)s, do). However, non-spouse beneficiaries would still need to take all the funds within the 10-year window.
What should beneficiaries do now?
The changes to inherited IRAs discussed above seem likely to pass. But until that happens, most individuals may want to consider a wait-and-see approach. If the inherited RMD distribution rules do change, make sure to consult your financial and tax professional to assess the implications and evaluate any potential planning opportunities. Particularly for beneficiaries inheriting a large retirement account in prime earning years, the tax impact may be significant.
Article is for informational purposes only and should not be misinterpreted as personalized advice of any kind or a recommendation for any specific investment product, financial or tax strategy. Do not use this article as the basis for making any type of tax, financial, legal, or investment decision.
¹There are three exceptions to the 10-year rule:
1. Minor beneficiaries have until the age of majority (under the proposal, age 21) before the 10-year payout period begins.
2. The 10-year rule doesn’t apply to beneficiaries less than 10 years younger than the decedent, or
3. If the beneficiary is disabled. The new proposal sets criteria for qualifying for disability status based on age and other factors.
²Beneficiary’s age and the IRS’ Uniform Lifetime Table