The introduction of the SECURE Act and its subsequent amendments have significantly impacted the distribution rules for inherited retirement accounts, particularly with the implementation of the 10-year rule, which limits the ability to stretch out distributions.
Due to the intricate nature of the updated RMD regulations and the severe implications of making mistakes, Glenn Van Gieson of Van Gieson Financial Advisor, a registrered and experienced CFP® suggests that individuals should seek advice from both a qualified financial advisor, particularly a Certified Financial Planner, and a tax expert. This will help people to understand how these rules pertain to their unique circumstances and avoid mistakes that may hurt their financial situation.
New Distribution Rules for Inherited Retirement Accounts
The Setting Every Community Up for Retirement Enhancement (SECURE) Act, enacted in 2019, introduced significant changes to how distributions from inherited retirement accounts must be managed. For most nonspouse beneficiaries inheriting accounts after 2019, the SECURE Act’s 10-year rule mandates that the account be fully withdrawn within a decade of the original owner’s passing, with certain exceptions in place. If an exception is applicable, the account must still be entirely distributed within 10 years of either the beneficiary’s death or, in the case of a minor child beneficiary, once they reach 21 years of age. This change curtails the ability to spread out withdrawals over an extended period, commonly referred to as “stretching” distributions.
In 2022, the IRS released proposed regulations to clarify the revised required minimum distribution (RMD) rules. These regulations, now finalized and set to take effect in 2025, align closely with the initial proposals while incorporating modifications from the SECURE 2.0 Act of 2022. Additionally, adjustments were made in response to public feedback on the proposals. Under these final rules, certain beneficiaries might need to take annual required distributions alongside a complete distribution at the end of a 10-year period. It is crucial for account owners and their beneficiaries to familiarize themselves with these changes to understand their potential impact.
Basics of Required Minimum Distributions (RMDs)
For those holding an individual retirement account (IRA) or participating in a retirement plan such as a 401(k), RMDs typically must commence the year you reach your specific RMD age. This age varies: it’s 70½ for individuals born before July 1, 1949, 72 for those born between July 1, 1949, and 1950, 73 for those born between 1951 and 1959, and 75 for those born in 1960 or later. If you’re still employed by the company that sponsors your retirement plan, you might be able to delay RMDs from that account until you retire. Missing an RMD can be costly, as a penalty tax of 25% (reduced from 50% before 2023) applies to the portion of the RMD that is not taken.
Your first RMD, known as the required beginning date (RBD), must be taken no later than April 1 of the year following the one in which you reach your RMD age. Subsequent annual distributions must be made by December 31 of each year. It’s important to note that delaying your first RMD until April 1 may necessitate taking two distributions within the same year: one by April 1 and another by December 31.
Roth accounts, on the other hand, have different rules. Since lifetime RMDs are not required from Roth accounts, Roth account owners are always considered to have passed away before their RBD. This rule applied exclusively to Roth IRAs before 2024 but will extend to Roth employer retirement plans thereafter.
Upon your death, the RMD rules determine how swiftly your retirement plan or IRA must be distributed to your beneficiaries. These rules largely depend on the beneficiaries you’ve designated and whether you die before or after your RBD.
Understanding the 10-Year Rule
Despite the SECURE Act’s 10-year rule, certain beneficiaries, known as eligible designated beneficiaries (EDBs), still retain the ability to stretch distributions to some degree. EDBs include your surviving spouse, your minor children, individuals no more than 10 years younger than you, and those who are disabled or chronically ill. EDBs can take annual distributions based on their remaining life expectancy. However, once an EDB dies or a minor child reaches 21, any remaining funds must be distributed within the following 10 years. Importantly, if your designated beneficiary is not an EDB, the entire account must be withdrawn within 10 years of your death.
For non-EDBs, the timing of your death relative to your RBD significantly influences distribution requirements:
- If you die before your RBD: No distributions are required during the first nine years after your death, but the entire account must be distributed in the 10th year.
- If you die on or after your RBD: Annual distributions based on life expectancy are required during the first nine years, with the remaining balance to be distributed in the 10th year. These annual distributions will be calculated based on the greater of your remaining life expectancy or that of your beneficiary.
Special Rules for Nonspouse EDBs
When your beneficiary is a nonspouse EDB, annual distributions will be required based on life expectancy after your death. If you pass away before your RBD, these distributions will be based on the EDB’s life expectancy. Conversely, if you die on or after your RBD, the distributions will be based on the greater of what would have been your life expectancy or your beneficiary’s life expectancy.
After your EDB beneficiary dies or reaches 21 (if they are your minor child), the remaining funds must be distributed within the 10th year following that event.
Spousal Beneficiary Considerations
There are specific rules if your spouse is the designated beneficiary. The 10-year rule generally does not take effect until after your spouse’s death, or possibly after the death of your spouse’s designated beneficiary.
Annual required distributions, whether based on your life expectancy or that of your nonspouse beneficiary, are calculated by dividing the account balance as of December 31 of the previous year by the applicable denominator for the current year. The RMD will never exceed the entire account balance on the date of the distribution.
When the applicable denominator is reduced to zero using the “subtract one” method, the account must be fully distributed in that year. Any remaining balance at the end of the appropriate 10-year period must also be distributed.
Relief for Missed RMDs in 2024
The IRS has provided relief from the penalty tax for individuals who failed to take required annual distributions during certain 10-year periods. This relief applies to situations where the IRA owner or employee died in 2020, 2021, 2022, or 2023, and the designated beneficiary (who is not an EDB) did not take required distributions for 2021, 2022, 2023, or 2024. Similar relief is available if an EDB died in these years and missed distributions for the same period.
Given the complexity of the RMD rules and the serious consequences of errors, it’s advisable to consult with a both a financial advisor such as a CFP and a tax professional to understand how these regulations apply to your specific situation.
