Beginning in 2025, certain non-spouse owners of inherited IRAs and other inherited qualified retirement accounts will need to take an RMD. This requirement is in addition to fully depleting accounts under the “10-year rule.”
Secure Act Rules Refresher
The Secure Act, passed in December 2019, made significant changes to distribution requirements of inherited qualified retirement accounts. These changes affect accounts inherited on or after January 1, 2020, and generally apply to IRAs, 401(k)s, and 403(b)s, among others (further referred to as “inherited accounts”). Most notably, the new regulations created the “10-year rule” for accounts inherited by non-eligible designated beneficiaries. The 10-year rule stipulates that inherited accounts must be fully distributed by December 31 of the tenth year starting in the year after the original account owner’s passing. Eligible designated beneficiaries continue to benefit from the ability to stretch distributions over their life expectancies with additional flexibility for surviving spouses. The remainder of this article will focus on the non-eligible designated beneficiary category.
*Eligible until age of majority is reached, at which time the 10-year rule will take effect
Under the initial Secure Act provisions, it was understood that non-eligible designated beneficiaries only needed to comply with the 10-year rule. However, in 2022 the IRS suggested otherwise and proposed that annual RMDs would also need to be taken by certain beneficiaries. In July 2024 the IRS finalized those proposed regulations and answered the big question:
Do I need to take annual RMDs?
- Yes – if the original account owner (decedent) reached their required beginning date
- No – if the original account owner (decedent) had not yet reached their required beginning date
The required beginning date is the date when the original account owner was or would have been required to begin taking RMDs and is based on their age. In other words, if the decedent had already begun taking RMDs, the beneficiary inheriting the account will now also need to take RMDs along with fully distributing the account in 10 years. This rule is effective January 1, 2025, requiring non-eligible designated beneficiaries to take their first RMD in 2025, if #1 above applies. Beneficiaries will not be required to make up RMDs not taken in previous years, and the IRS has also waived associated penalties for not taking a distribution. It’s also important to note that the finalization of the proposed regulations does not reset the initial 10-year clock. For example, a beneficiary who inherited an IRA in 2020 will still need to fully distribute the account by December 31, 2030.
Roth Accounts Inherited by Non-Eligible Designated Beneficiaries
The 10-year rule applies to both pre-tax (traditional) and Roth retirement accounts inherited by non-eligible designated beneficiaries. A nuance arises with respect to the annual RMD rules. Inherited Roth IRAs, specifically, do not have annual RMD requirements. Inherited Roth 401k(s) and 403(b)s are a bit more complex. In the latter cases RMDs are not required by beneficiaries if the decedent (1) passed prior to their required beginning date, or (2) only had a balance in the Roth portion of the plan (no balance in the pre-tax portion). Otherwise, if the decedent had balances in both pre-tax and Roth portions of the plan along with having passed after their required beginning date, both the pre-tax and Roth 401(k)/403(b) are subject to RMDs by the beneficiaries. This nuance presents a benefit to rolling over Roth 401(k) or 403(b) balances to a Roth IRA. Also, it is important to note that Roth IRA distributions are tax-free if the account meets the five-year rule. This rule applies from the date of the original owner’s first Roth IRA contribution.
Strategic Planning
Maximizing after-tax benefits requires careful planning for beneficiaries who have inherited retirement accounts under the new RMD and 10-year rules. Provided below are some considerations:
- Some circumstances may warrant taking more than the RMD each year. A beneficiary who needs only to comply with the 10-year rule (no RMDs) may benefit from taking earlier or even annual distributions. In other situations, taking the minimum or delaying distributions may be best – kicking the can down the road. The best outcomes are likely to be realized by a thoughtful review of an individual’s current and future expected tax circumstances along with the account specifics.
- It is equally important for retirement account owners to begin thinking strategically about their future heirs and what assets they intend to transfer. This is particularly true for account owners with large pre-tax (traditional) balances. Often beneficiaries are in their highest earning years when they inherit assets, and these new rules limit options from a tax optimization standpoint. Opportunities to review Roth conversions have taken on new meaning.
- In addition, an annual review of your IRA beneficiaries is also prudent. For example, does it make sense to add contingent beneficiaries? This may provide more optionality upon death. This may include a charitable beneficiary. For these reasons, it would be advisable to review current beneficiaries and future giving plans to determine the best resources to leverage.
Navigating the complexities of inherited IRAs can be daunting, especially with recent regulatory changes. These changes impact both those who have inherited accounts and those planning for their beneficiaries. If you’re unsure how these rules affect you, our advisors can help. We can discuss your specific situation and develop a strategy to minimize taxes and maximize the benefits of the inherited IRA.
Disclosure: The information provided here is for general educational and informational purposes only. It does not constitute legal, tax, or investment advice, and should not be relied upon as such. JFSWA is not a law firm or an accounting firm. Any financial or business decisions should be made only after consulting with a qualified legal, tax, or financial advisor who can assess your specific situation.
