On July 19, 2024, the IRS issued final rules on required minimum distributions (RMDs) for non-spouse beneficiaries who inherit individual retirement accounts (IRAs). Note that the following refers to inherited traditional IRA accounts, not a Roth IRA which has different distribution rules. Although new laws on RMDs were included in the Setting Every Community Up for Retirement Enhancement Act (SECURE Act), they were ambiguous, which led to the final rules issued this summer.
Prior to 2020, non-spouse beneficiaries were required to begin taking RMDs no later than December 31 of the year following the death of the original IRA account holder. The non-spouse beneficiary could spread out the RMDs over their own life expectancy. This tax strategy was referred to as the “stretch IRA.” It was not a type of IRA, but rather a wealth transfer method. This estate planning strategy extended IRA RMDs over future generations while the IRA grew tax-free. The RMDs were based on age, and it was of particular benefit to grandchildren and great-grandchildren, who had a smaller RMD, allowing the account to grow tax-free.
However, “eligible designated beneficiaries” are exempt from the new rules and can still benefit from the “stretch IRA.” The IRS defines an “eligible designated beneficiary” as a spouse or minor of the deceased account holder, disabled or chronically ill individual, or an individual who is not more than 10 years younger than the IRA owner or plan participant. In addition, if the death of the IRA account holder occurred in 2020 or later, and the beneficiary is the spouse, they may keep the IRA as an inherited account, take distributions based on their own life expectancy, or rollover the account into their own IRA.
If the beneficiary is a non-spouse beneficiary or “designated beneficiary” and the death of the IRA account holder occurred in 2020 or later, the new rules apply. One of the first steps is to determine if the original account holder had begun taking RMDs or had reached the age where they should have started taking them. According to the finalized IRS rules, non-spouse beneficiaries who inherit an account from someone who was already taking RMDs will be required to take distributions each year, commencing in the calendar year following the account owner’s death, and then continue to take them until the account is depleted by the end of year ten.
On the other hand, if the original IRA account owner had not yet been obligated to take distributions, the non-spouse beneficiary will not be required to take an annual distribution. This could be helpful to the beneficiary if they wait until they are in a lower tax bracket to take the distribution later in the 10-year window.
Note that any taxes on the IRA distributions that would have been owed by the deceased will now be owed by the beneficiary.
The IRS also clarified that if the original IRA account owner died in 2020-2023, and was already subject to RMDs, the IRS won’t penalize the beneficiary for any missed distributions, nor will the distributions need to be caught up. However, the years missed will be subtracted from the 10-year period. For example, if the RMDs were not taken for two years, the beneficiary will only have eight years to deplete the IRA from the year of the original account owner’s death. These rules do not take effect until 2025, and only apply to IRAs inherited after 2019.
Inherited Roth IRAs: The SECURE Act and the SECURE Act 2.0 also included rules regarding inherited Roth IRAs. Only spouses, minor children of the deceased, those disabled or chronically ill, or those who aren’t more than 10 years younger than the deceased will be able to keep the Roth IRA longer than 10 years. The 10-year period to deplete the inherited Roth IRA applies to all non-qualifying heirs.