The Internal Revenue Service (IRS) has released final rules concerning mandatory distributions from traditional 401(k)s, IRAs, and other retirement plans inherited in 2020 or later. These new requirements, which were enacted following the passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act in December 2019, apply to non-spouse beneficiaries who are required to withdraw money from an inherited retirement account over a 10-year period. The complexity of these rules has caused confusion and frustration among financial planners and beneficiaries alike.
Under the new rules, when the deceased IRA owner was old enough to be making required minimum distributions (RMDs) before their death, non-spouse beneficiaries are subject to mandatory distributions over a 10-year period, with requirements to draw money out each year. The amount that must be withdrawn is determined by an IRS life-expectancy table. Those who miscalculate the amount or neglect the chore altogether will face a penalty of 25% of the amount that should have been withdrawn but was not.
The complexity of these new rules stems from the SECURE Act’s elimination of the “stretch IRA,” which previously allowed beneficiaries to minimize distributions by spreading them out over their life expectancies. Instead, most non-spouse beneficiaries are now required to completely empty an inherited IRA by December 31 of the year containing the 10th anniversary of the account owner’s death. For example, an adult child who inherited an IRA from a parent who died in October 2021 would have until December 31, 2031 to take all the money out.
The IRS faced criticism when it initially stated that these mandatory distributions must be made every year, instead of just once at the end of the 10-year period as many tax professionals and financial planners had assumed. After taking about two years to reconsider its stance, the IRS ultimately imposed the same complex requirement in July through final rules.
The new provision applies to those who inherited an IRA from someone who died in 2020 or later. Between the SECURE Act’s passage in 2019 and this summer’s announcement, countless beneficiaries were subjected to a multi-year bureaucratic fiasco, unsure of what they were supposed to do. In an unusual display of mercy, the IRS stated that it would not penalize anyone who did not take a required distribution in 2021, 2022, 2023, or 2024. However, starting in 2025, affected beneficiaries will have to start taking RMDs, with no need to “make up” for the years when the IRS waived penalties. The 10-year clock is still based on the year of death, and those who inherited an IRA from someone who died in 2019 or earlier are not subject to these new rules.
It may be in the best interest of some beneficiaries to take out more than the RMD each year, depending on factors such as potential tax bracket changes and future tax rate uncertainties. Financial institutions have begun offering tools to help with inherited IRA RMD calculations, but many tax professionals and financial planners remain frustrated by the complexity of these new requirements. The maddening intricacies of income tax laws leave some wishing that 1913 had never happened.
