Interpreting The Rules For Inherited IRA Distribution

Taking IRA distributions is often confusing, more so if you are inheriting an IRA. Part of the reason I eventually became a financial planner is due to my own experience trying to find accurate advice regarding a retirement account I inherited when my mom died in 1998.

Looking back, those rules were simple. I could spread those distributions out over my lifetime based on a simple mortality table. These were known as “stretch” provisions and made managing taxes over my lifetime manageable and allowed the account to continue to grow tax-deferred. To qualify for this option, I needed to take my first distribution by the end of the year following the year of my mom’s death. In my case, that would have been by Dec. 31, 1999. Had I missed this deadline, I would have been required to deplete the account in five years.

The SECURE Act of 2019 and SECURE 2.0 resulted in many non-spouse beneficiaries being unable to extend inherited IRA distributions throughout their lifetimes. Most non-spouse beneficiaries must now deplete the account within 10 years of the original owner’s death. Pending IRS guidance, the original interpretation was that funds could be withdrawn anytime within that 10-year time frame, much like the original five-year rule.

In February 2022, the IRS issued proposed regulations, stipulating that IRA owners subject to the 10-year rule were also subject to a required minimum distribution (RMD), as well. The 2022 guidance created more confusion for beneficiaries and financial professionals. As the IRS worked to clarify its guidance, it agreed to waive all penalties for not taking these distributions during the 2021-2024 period. Final IRS rules were issued in July and will be effective in 2025.

These final rules specify who is subject to required minimum distributions during the 10-year window. Most non-spouse beneficiaries will now fall into one of three classes:

◗   Original IRA owner dies before beginning their required minimum distributions.

◗   Original IRA owner dies on or after taking required minimum distributions.

◗   Successor beneficiaries, those who inherit an inherited IRA, can also be known as second-generation beneficiaries.

Under the final rules, if a person inherits an IRA from someone who died before they were taking required minimum distributions, that beneficiary has the flexibility to take the money out at any time during the 10-year period. The requirement is that all the money must come out before the last day of the 10th year.

If the deceased IRA owner had been taking required minimum distributions, the beneficiary would fall under an “at least as rapidly” (ALAR) rule. This means these beneficiaries need to continue taking annual required minimum distributions based on their life expectancy. Before the end of the 10th year, any remaining assets would have to be distributed in full. The IRS has confirmed that there will be no penalties and no requirement to make up the missed distributions for beneficiaries who didn’t take their RMDs in 2021–2024.

Inheriting an inherited IRA is more complicated. Depending on the circumstances, successor beneficiaries, those who inherit an inherited IRA, might need to either begin a new 10-year period, after which the account must be fully distributed, or finish out the original beneficiary’s 10-year period. If the original beneficiary was stretching distributions (which could be because they inherited before the SECURE Act’s effective date or because they were an eligible designated beneficiary), the successor beneficiary will become subject to the 10-year rule. If the original beneficiary was subject to the 10-year rule, the successor beneficiary will finish out the original beneficiary’s 10-year period.

Inheritance and tax laws can be complex, and individual circumstances vary, so seeking professional guidance can help beneficiaries make informed decisions. In some instances, converting a taxable IRA to a non-taxable Roth IRA will minimize taxes for your beneficiaries. Consult a qualified tax adviser or financial planner to navigate specific tax implications of any proposed strategy.