It’s common for individuals to pass with a significant balance still in their IRA accounts. This could be anywhere from tens of thousands to millions of dollars. Depending on the individual’s will, this amount is typically first passed to a spouse, and then to children when the second spouse passes.
If you inherit your spouse’s IRA account, there are no taxes to be paid, and this money is considered to be your own. However, if you’re inheriting an IRA from someone you are not married to (such as a parent, grandparent, aunt, or uncle), there are rules in place that govern how you can access these funds.
Before 2020, individuals that inherited IRAs had two choices: to take the money as a lump sum and pay taxes on that amount or to place the funds in a specially-designated inheritance IRA, which could then be drawn down over their lifetime.
However, the passage of the Secure Act in 2019 and the recent issuance of IRS final regulations have fundamentally changed these rules. Let’s take a closer look.
What Are the New Tax Rules for Inherited IRAs?
Most heirs excluding surviving spouses under the SECURE Act have to remove the whole balance of an inherited IRA or defined contribution plan within ten years of the death of the original account owner. The recently issued IRS final regulations have provided clarification and some additional complexity to these rules, especially for heirs subject to the “10-year rule.”
RMD Rules in Effect for 2024
The rules now mandate annual RMDs to be taken in Years 1 through 9 following the death of the original account owner, with the remaining balance distributed by the end of Year 10 for beneficiaries inheriting an IRA or defined contribution plan from someone who had already begun taking RMDs (referred to as the “required beginning date,” or RBD). This annual withdrawal need reduces tax planning options and may force beneficiaries into higher tax bands during these years.
For example, let’s imagine Jane inherited an IRA from her mother in 2021 who had started RMDs. Jane won’t have to take RMDs for 2022 through 2024 under the extended waiver set by the IRS Starting in 2025, Jane must, however, complete annual RMDs until 2030 with the account entirely disbursed by the end of 2031.
If Jane’s mother had deceased before beginning her RMDs, Jane may have postponed distributions entirely until Year 10, therefore enabling the account to grow unaltered for most of the 10-year period.
The final regulations apply to RMDs beginning in 2025; non-complying beneficiaries risk a 25% penalty on missed withdrawals (reduced to 10% should they be repaired within two years).
Temporary Waivers and Relief
Recognizing the confusion these changes have caused, the IRS has offered relief. Beneficiaries who inherited accounts from individuals passing away in 2020 through 2023 after the RBD have been granted waivers on penalties for missed RMDs during those years. Starting in 2024, however, beneficiaries will need to comply with the annual RMD requirements.
