Inherited IRA rules: cutting through the confusion

Following the release of Internal Revenue Service (IRS) proposed regulations in February 2022, there’s been some confusion about when beneficiaries must start taking required minimum distributions (RMDs) from inherited individual retirement accounts (IRAs). Until the proposed regulations are finalized — and there has been no announced timetable for that — our guidance to beneficiaries is two-fold:

• Follow the rules established by the SECURE Act, the retirement law passed in 2019 that introduced a new 10-year payout rule for inherited qualified-plan accounts.
• Familiarize yourself with the IRS’s proposed regulations, which interpret various aspects of the 2019 law, and be ready to comply if new RMD practices are part of the final regulations.

The rules related to RMDs have major tax ramifications, as inheritors must pay income taxes on funds as they are withdrawn. If you own an inherited IRA account, here are some specifics on what you need to know about the rules introduced by the 2019 law and the new practices you may need to adopt when IRS regulations interpreting that law are finalized:
 

SECURE Act changes (the rules today)

In 2019, the SECURE Act changed the rules for distributing assets from an inherited IRA. With its passage, most non-spouse beneficiaries who inherited IRA assets on or after Jan. 1, 2020, are required to withdraw the full balance of the account within 10 years. This includes adult children and grandchildren and most other designated beneficiaries.

Previously, if you inherited an IRA, or a 401(k) that you converted into an inherited IRA, you could “stretch” your account distributions — and the related tax obligations — over your life expectancy.

The SECURE Act eliminated the “stretch” provision and replaced it with the new 10-year payout rule.

It's important to note that the SECURE Act does not say beneficiaries must withdraw a certain amount, or a certain percentage, of the account balance in each of the 10 years. In other words, it does not dictate RMDs. The law just says you must empty an inherited IRA account by the end of the 10th year following the year of the original IRA owner’s death. As such, it was interpreted by many advisors to allow for a decade’s worth of tax deferral by waiting until the final year to make any withdrawals.

Note, however, that the SECURE Act allows for some exceptions to the 10-year payout rule. It does not apply to the following categories of beneficiaries:

• An IRA owner’s spouse
• An IRA owner’s minor child
• Someone not more than 10 years younger than the IRA owner
• Someone disabled or chronically ill (as defined by the IRS)

Proposed IRS regulations (and how you may need to pivot)

In February 2022, the IRS issued 275 pages of proposed regulations interpreting the SECURE Act. Beneficiaries need to be ready for any new position the regulations may take on RMDs.

Under the proposed regulations, if you inherit an IRA from someone who had already passed their required beginning date for RMDs, you can’t wait until year 10 to withdraw the full inherited IRA account balance and benefit from 10 years of tax deferral. Beneficiaries would have to take annual distributions in years 1 to 9 and the remaining balance in year 10. In other words, the position of the IRS is that once an IRA owner has begun taking annual RMDs, the beneficiary must continue taking RMDs based on the SECURE Act 10-year payout rule.

Typically, the IRS will finalize regulations within a year or two after releasing the proposed regulations and reviewing public comments. It is not clear when to expect final regulations and whether the IRS intends to finalize the regulations as proposed or to alter them to reflect the current interpretation under the SECURE Act. 

So what should you do now about RMDs? Our guidance is to follow the common interpretation of the rules established by the SECURE Act, as described above, until the proposed IRS regulations are finalized. However, if you have inherited an IRA and want to be especially cautious, you can always start following the proposed IRS regulations now and take annual distributions.

Stay in touch with your advisors

If you are unsure about how to handle RMDs from your inherited IRA accounts, talk to your financial and tax advisors. And be sure to keep in touch with them so you are aware of it when the IRS regulations interpreting the SECURE Act are finalized. When that happens, you will want to review with your advisors how the final regulations impact your particular situation, so you know how to handle distributions on your inherited IRAs going forward.

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