New inherited IRA withdrawal rules beneficiaries need to know
Fiduciary Trust International
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If you recently inherited an IRA, the latest IRS rules may impact the timing and amount of distributions you are required to take.
The new IRS regulations give final clarification to provisions in the SECURE Act of 2019 that require most non-spousal beneficiaries to deplete their inherited IRA within a decade. The previous interpretation of this law, which did not specify withdrawal schedules, suggested the possibility that beneficiaries could defer distributions until the 10th year to keep more assets in the account and maximize tax-deferred growth.
Under the latest regulations, the ‘10-year rule’ specifies when and how much you must withdraw. The 10-year withdrawal period doesn’t apply to eligible designated beneficiaries, including surviving spouses, who are given more flexibility in determining their distributions from an IRA (more on their options below).
10-year withdrawal rules if the deceased owner was already taking RMDs
If you inherited an IRA from someone who was already taking required minimum distributions (RMDs), you are required to continue taking RMDs. The RMD amount is an IRS calculation based on life expectancy and market value of the IRA. The annual distributions for years one through nine are calculated with the IRS single life expectancy table, using the younger of your age or the deceased owner’s age at their birthday in the year of their death. When you reach the tenth year, you must withdraw any remaining assets from the account.
10-year withdrawal rules if the deceased owner was not taking RMDs
If the original owner did not have required distributions when the account was passed to you, then you have until the end of the 10-year term to deplete the inherited account. This would generally apply to original owners who passed away in 2020 or later prior to reaching age 72 or 73.
Beginning in 2023, the SECURE 2.0 Act raised the age that you must begin taking RMDs to age 73. If you reached age 72 in 2023, the required beginning date for your first RMD is April 1, 2025, for 2024.
10-year withdrawal rules if you inherited a Roth IRA
Original owners of a Roth IRA are not subject to the same required distributions that apply to traditional IRAs. If you inherited a Roth IRA from a non-spouse, you have until the end of the 10-year term to empty the account. Distributions from a Roth IRA are generally tax-free if the Roth IRA was held by the original owner for at least five years.
Making up for missed years
If you inherited a traditional IRA between 2020 and 2024 and have not yet taken any 10-year distributions, you won’t be penalized. However, the 10-year clock that started when you inherited the account is not extended.
You must begin taking annual distributions in 2025. You may take a higher distribution than the RMD in any year if desired, but you must take at least the RMD.
If you miss a year of required withdrawals after the grace period ending in 2024, the current penalty is 25% of the amount that should have been withdrawn.
Be aware of taxes
It’s important to remember that distributions from traditional retirement accounts are taxed as ordinary income. You’ll want to think carefully about when to take withdrawals and whether you want to take more than the minimum amount. This is especially relevant if the original owner was not yet taking distributions, leaving you with no annual minimum requirements throughout the 10-year period.
Here are some key points to consider as you evaluate your withdrawal strategy:
What do you want to do with the IRA? If your goals are longer term, you may want to take minimum withdrawals initially to realize a smaller tax bite on your distributions while allowing the remaining assets in the account to continue growing tax deferred. If your goals are shorter-term, such as buying a home or remodeling in the next year, you may be willing to sacrifice potential tax savings to have access to more funds when you need them.
If you plan to take larger distributions in certain years, it’s smart to time those for years when your tax liability may be lower. Identify any potential changes that might lie ahead for your income level or for tax deductions. For example, if you plan to retire in the next few years, consequently seeing a reduction in your annual income, it may be beneficial to wait until you retire and take a larger distribution during a lower-income year. Or if you plan to make a large charitable contribution, you could coordinate this with taking your large distribution to help offset the tax impact.
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Don’t forget about state income taxes when taking distributions. Tax rates differ from state to state, and some states treat retirement account distributions more favorably than others.
The benefit of tax-deferred growth in the IRA depends largely on how its assets are invested. Review your overall investment plan, determine how the IRA will fit into your strategy, and adjust the investment allocation accordingly.
These might include life events that impact your finances, such as marriage, divorce, early retirement, un-retirement, or the birth of additional children. Also keep in mind that tax rules are not set in stone, so your assumptions about future taxes could change. For example, there is current uncertainty surrounding the 2025 sunset of the Tax Cuts and Jobs Act. If those provisions are allowed to expire, it may increase rates for some taxpayers.
What if you are a beneficiary who is a spouse or other eligible designated beneficiary?
Remember, the 10-year withdrawal period doesn’t apply to surviving spouses. If you inherited an IRA from your spouse, you generally can roll the assets into an IRA in your name, treating the assets as if they were your own. Alternatively, if you are older than your deceased spouse, it may be beneficial to transfer the IRA into an inherited IRA and delay required distributions or decrease required distribution amounts.
The 10-year rule also doesn’t apply to other eligible designated beneficiaries, including minor children, chronically ill or disabled individuals, or if the beneficiary is less than 10 years younger than the deceased original owner.
If you are the beneficiary of a trust that owns an inherited retirement account, the terms of the trust will impact distributions to you.
If you have questions about your inherited IRA, your tax situation, or your strategies in light of the new regulations, our advisors can help you create a personalized plan that is flexible and works for you.
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