Inherited IRA's and the 10-year Rule

The Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) changed the rules for taking distributions from retirement accounts inherited after 2019. The so-called 10-year rule generally requires inherited accounts to be emptied within 10 years of the original owner's death, with some exceptions. Where an exception applies, the entire account must generally be emptied within 10 years of the beneficiary's death or within 10 years after a minor child beneficiary reaches age 21. This reduces the ability of most beneficiaries to spread out, or "stretch," distributions from an inherited defined contribution plan or an IRA.

In 2022, the IRS issued proposed regulations that interpreted the revised required minimum distribution (RMD) rules. Final regulations have now been issued and are generally applicable starting in 2025. They basically adopt the proposed regulations, while reflecting some changes made by the SECURE 2.0 Act of 2022 and including certain changes in response to comments received on the proposed regulations. Under these regulations, some beneficiaries could be subject to annual required distributions as well as a full distribution at the end of a 10-year period. Account owners and their beneficiaries may want to familiarize themselves with these changes and how they might be affected by them.

RDM basics

If you own an individual retirement account (IRA) or participate in a retirement plan like a 401(k), you generally must start taking RMDs for the year you reach your RMD age. RMD age is 70½ (if born before July 1, 1949), 72 (if born July 1, 1949, through 1950), 73 (if born in 1951 to 1959), or 75 (if born in 1960 or later). If you are still working for the employer that maintains the retirement plan, you may be able to wait until the year you retire to start RMDs from that account. Failing to take an RMD can be costly: a 25% penalty tax (50% prior to 2023) generally applies to the extent an RMD is not made.

The required beginning date (RBD) for the first year you are required to take a lifetime distribution is no later than April 1 of the next year. After your first distribution, annual distributions must be taken by the end of each year. (Note that if you wait until April 1 to take your first-year distribution, you would have to take two distributions for that year: one by April 1 and the other by December 31.)

Who is subject to the 10-year rule?

The SECURE Act still allows certain beneficiaries to "stretch" distributions, at least to some extent. These eligible designated beneficiaries (EDBs) include your surviving spouse, your minor children, any individual not more than 10 years younger than you, and certain disabled or chronically ill individuals. Generally, EDBs are able to take annual required distributions based on remaining life expectancy. However, once an EDB dies, or once a minor child EDB reaches age 21, any remaining funds must be distributed within 10 years. Significantly, though, the SECURE Act requires that if your designated beneficiary is not an EDB, the entire account must be fully distributed within 10 years after your death.

What if your designated beneficiary is not an EDB?

If you die before your RBD, no distributions are required during the first nine years after your death, but the entire account must be distributed in the 10th year. If you die on or after your RBD, annual distributions based on remaining life expectancy are required in the first nine years after the year of your death, then the remainder of the account must be distributed in the 10th year. Annual distributions after your death will be based on the greater of (a) what would have been your remaining life expectancy or (b) the beneficiary's remaining life expectancy.

What if your beneficiary is a nonspouse EDB?

After your death, annual distributions will be required based on remaining life expectancy. If you die before your RBD, required annual distributions will be based on the EDB's remaining life expectancy. If you die on or after your RBD, annual distributions after your death will be based on the greater of (a) what would have been your remaining life expectancy or (b) the beneficiary's remaining life expectancy. After your beneficiary dies or your beneficiary who is your minor child turns age 21, annual distributions based on remaining life expectancy must continue during the first nine years after the year of such an event. The entire account must be fully distributed in the 10th year.

The rules relating to required minimum distributions are complicated, and the consequences of making a mistake can be severe. Talk to a tax professional to understand how the rules, and the new regulations, apply to your individual situation.

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