When saving for retirement, the sad truth is that sometimes our family members or heirs will be the ones to enjoy the fruits of our labor. Inherited Individual Retirement Accounts (IRAs) are common occurrence, and knowing the rules surrounding them and their distribution is very important so as to not acquire unwanted tax burdens and fines in the wake of an already difficult and emotional situation.
Until now, and as stated in the Secure Act of 2019, beneficiaries inheriting IRAs from 2020 onwards had ten years from the original owner’s death to withdraw the entirety of the funds from the account. This allowed for distributions to be spread out evenly over a few years and accommodate them to their lifestyle, helping reduce the tax burden. Prior to that, IRA beneficiaries could stretch distributions over their lifetime, and although that is still an option for some beneficiaries, most of them are subject to the ten year rule.
But rules are about to change even further. The implementation of the SECURE Act 2.0 will mean that in 2025 there will be some significant changes that will impact how beneficiaries manage inherited retirement accounts.
Amongst the new changes the Secure Act 2.0 aims to clarify the confusion about the withdrawal rules that have been expressed by beneficiaries. As Joel Dickson, global head of advice methodology at Vanguard states “You have a multi-dimensional matrix of outcomes for different inherited IRAs” and it is hard to keep up with what rules correspond to your specific case.
Changes to IRA beneficiary rules
Many people understood the ten year rule as a maximum amount of time that beneficiaries had to empty their inherited IRAs, but the Internal Revenue Service (IRS) has had to clarify that there are required yearly minimum distributions (RMDs) that most beneficiaries will have to follow in order to be in compliance with the ten year rule.
Focusing just on those who will need to abide by the ten year rule, RMDs will have to be taken annually beginning in 2025. Those who have not done so before will not be penalized, but moving forward, if an annual RMD withdrawal is missed, beneficiaries will be subject to a 25% penalty on the needed amount on top of still having to withdraw the amount and having to pay taxes on it. This penalty can be reduced to 10% with timely correction.
Not all inherited IRAs will be subject to these RMD withdrawals. Spouses have some options that the IRS sanctions that will allow them to follow other set of rules.
If the account holder’s death occurred prior to the required beginning date of their own RMDs, the surviving spouse will be able to roll the amount in the account to their own IRA account and abide by their own timeline. The options, as outlined by the IRS are:
To keep the IRA as an inherited account, in which case a spouse can
- Delay beginning distributions until the employee would have turned 72
- Take distributions based on their own life expectancy
- Follow the 10-year rule
- Roll over the account into their own IRA
But, if the account holder’s death occurred after the required RMD beginning date, the spouse beneficiary may:
- Keep the inherited IRA as an inherited account and as such take distributions based on their own life expectancy, or
- Rollover the account into their own IRA
“Eligible designated beneficiaries” like a spouse or minor child of the deceased account holder, disabled or chronically ill individuals and beneficiaries that are not more than 10 years younger than the IRA owner or plan participant can also have exemptions to the ten year rule and “take distributions over the longer of their own life expectancy and the employee’s remaining life expectancy, or follow the 10-year rule (if the account owner died before that owner’s required beginning date)”.
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