The IRS recently changed its rules on required minimum distributions (RMDs) for inherited retirement accounts, especially based on the SECURE Act. Beneficiaries of retirement accounts must understand these new rules since they control how much money has to be taken out of a retirement account and when it has to be taken out. While the new regulations establish a general requirement that beneficiaries draw down inherited accounts within ten years, there are some striking exceptions to this general rule that can have enormous tax and financial planning implications.
Overview of RMD Rules
Under the SECURE Act, which was signed into law in December 2019, most non-spouse beneficiaries of inherited retirement accounts must withdraw the entire balance within ten years of the account holder’s death. That rule replaced the so-called “stretch IRA” strategy that allowed beneficiaries to take distributions over their lifetime, thus continuing tax-deferred growth.
However, the IRS has indicated that certain beneficiaries, known as Eligible Designated Beneficiaries, are exempt from this ten-year requirement and can, in fact, employ the stretch IRA method. The EDBs in this list include a surviving spouse, minor children of the deceased, any individual not more than ten years younger than the deceased, and a disabled individual.
Specific exceptions to the 10-Year Rule
Surviving spouses
The best treatment goes to surviving spouses. They can treat an inherited IRA as their own IRA and delay RMDs until they reach age 73, or 75 after 2033. This could make a dramatic difference in how much flexibility there is in managing withdrawals and tax implications.
Minor children
A minor child who inherit retirement accounts are also exempt from the ten-year rule until they reach the age of majority. Once such a person comes of age, he has to withdraw the balance within ten years. This provision thus continues tax-deferred growth throughout a child’s formative years.
Disabled individuals
Disabled beneficiaries are treated similarly to surviving spouses. They do not need to adhere to the ten-year rule and are allowed to take distributions based on their life expectancy. This exemption is also most valuable to persons with disabilities who might be relying on the funds to fund ongoing needs.
Individuals not more than ten years younger
This stretch IRA opportunity is also provided to beneficiaries that are not more than ten years younger than the deceased account holder. Because they fit within this exemption, they, too, can now take distributions over their life expectancy and will not be required to withdrawal the money within ten years.
Impact of the New RMD Rules
The new RMD regulations are full of implications for beneficiaries and their tax planning. Meticulous planning is required if one is subject to the ten-year rule, in order to avoid a huge tax burden. In general, distributions from inherited accounts are includable in gross income and require that the beneficiary, if not managed properly, sustains significant tax impacts that may propel them into higher tax brackets.
The ability to stretch out these distributions over a longer period of time can create great opportunities for tax-efficient planning with an EDB. This involves strategic withdrawal of funds, which will limit the overall tax liability and at the same time let the inherited assets continue growing and serving the beneficiaries.
Transitional relief and waivers
Appreciating the complexity and confusion created by these new regulations, the IRS has provided transitional relief for some missed RMDs. The IRS issued notices waiving penalties on beneficiaries who missed required distributions taken in earlier years. This would help beneficiaries who inherited accounts from somebody who had reached their required beginning date for RMDs but failed to take the requisite withdrawals.
New RMD Rules by the IRS
The new RMD rules from the IRS on inherited retirement accounts open up wide changes for beneficiaries to be very cautious about. Even though the ten-year rule creates an extremely strict requirement on withdrawal for the majority of beneficiaries, surviving spouses, minor children, disabled people, and those who are not more than ten years younger than the deceased are exceptions to this. These types of exceptions are, therefore, very important to understand in order to have effective financial planning and tax management. Beneficiaries should consult financial advisors or tax professionals to ensure they are adhering to the new rules and to maximize inherited retirement account withdrawal strategies.
