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Inherited IRA RMDs: How Recent Law Changes Impact You in 2024
Planning Alternatives October 11, 2023
IRAs (Individual Retirement Accounts) represent the largest pool of assets held in U.S. retirement accounts, with $13.6 trillion invested in the fourth quarter of 2023. The passing of assets to successive generations, known as the Great Wealth Transfer, is already in motion. In this era, it’s from baby boomers to gen X and millennials. The rules governing such transfers, referred to as inherited IRA RMDs, have been changing. Staying up-to-date on these modifications is crucial to avoid unintentionally creating financial hurdles for your beneficiaries and heirs.
Understanding IRA RMDs
You cannot keep funds in your IRA indefinitely. At some point, these funds will need to be withdrawn, i.e, distributed.
Required beginning date (RBD) is the date that you as an IRA owner must begin taking RMDs. As a rule, the RBD is April 1 of the calendar year following the calendar year in which an account owner reaches age 73.
Required Minimum Distributions (RMDs) are minimum amounts the IRS requires you to withdraw annually from traditional IRAs. These withdrawals are subject to ordinary income tax. As mentioned, typically, for your own IRA, you are required to begin taking RMDs starting at age 73 if you turn 72 after December 31, 2023. The RMD age will increase to 75 in 2033. If you do not distribute the funds from your IRA or the distribution is not large enough, you may have to pay excise tax on the amount that is not distributed as required.
Understanding Inherited IRA
When you inherit a traditional IRA – for example, from your parent or spouse – you are a beneficiary of it. A beneficiary can be any person or entity the owner chooses to receive the benefits of the IRA after the owner dies.
Note, if you inherited an IRA from your spouse and are the sole beneficiary of your deceased spouse's IRA, you have a choice to be treated either as the owner or the beneficiary. If you choose to be treated as the owner, you determine the required minimum distribution (if any) as if you were the owner beginning with the year you elect or are deemed to be the owner.
If you do not become the owner of the inherited IRA, you must begin receiving distributions from the IRA under the rules for distributions that apply to beneficiaries.
New Tax Regulations Impacting Inherited IRA RMDs
For those who inherit IRAs starting in 2020 or later, the IRS mandates that beneficiaries must take distributions and pay the accompanying taxes sooner than before. Here are the options:
- Take a lump sum, and pay taxes on the total amount.
- Transfer proceeds into an inherited IRA that must be fully depleted within 10 years after the original account owner's death. This is known as the “10-year rule.”
Flexibility for Spouses
If you inherited an IRA from a spouse, you can treat it as your own or roll it into your existing IRA, deferring RMDs until you reach the required age. This strategy benefits younger spouses who want the assets to grow tax-deferred.
Starting in 2024, a spouse who inherits an IRA from a younger spouse can employ “spousal delay” and have the option to base their RMDs, when due, on their deceased spouse’s life expectancy. This option allows for the RMDs to be based on the longer life expectancy of the younger deceased spouse as opposed to the older surviving spouse beneficiary.
RMD Exceptions for Minors
Children over the age of majority (18 in most states) must follow the general 10-year rule. For minors, a guardian manages the inherited assets until they reach adulthood, at which point they must withdraw the remaining funds within ten years. Exceptions apply if the child is pursuing advanced education, allowing for delayed withdrawals up to age 26.
On December 29, 2022, President Joe Biden signed the SECURE 2.0 Act into law. Effective, 2023, Section 302 of the SECURE 2.0 Act (Setting Every Community Up for Retirement Enhancement Act) created new rules related to the penalties for missed RMDs. Previously any missed RMD was subject to a 50% excise penalty. The SECURE 2.0 Act modifies these rules by reducing the penalty for missed RMDs to 25% and further reduces it by 10% under specific circumstances.
Inherited RMD Relief in 2024
Recent regulations have introduced some relief:
- 2022 Proposed regulations: Beneficiaries must take RMDs based on their life expectancy if the original owner died post-RBD, requiring full distribution by the end of the 10th year.
- 2023 Interim guidance: Beneficiaries are not penalized for not taking RMDs in 2021 or 2022 if they inherited an IRA where the owner died post-RBD.
- Extension in 2023: The IRS extended this relief, so no penalties apply for not taking RMDs in 2023.
- Extension in 2024: The IRS released Notice 2024-35, which extends previously issued temporary relief from certain required minimum distribution (RMD) requirements for beneficiaries under qualified defined contribution plans through Dec. 31, 2024.
Strategic Financial Planning for 2024
Given the significant shifts in inherited IRA RMD rules, it’s essential to adapt your financial planning strategies:
- Diversify assets: Relying solely on traditional IRAs could result in higher taxes for heirs. Consider diversifying into Roth IRAs or taxable brokerage accounts, which might offer favorable tax treatments.
- Revisit beneficiary designations: Strategies like splitting an IRA between multiple beneficiaries or naming a younger spouse as a primary beneficiary could ease the tax burden and provide better deferral opportunities.
- Consult a tax professional: Ensure you interpret these changes correctly and analyze your options with a tax professional.
Inherited IRAs and Family Wealth Transfers
The recent changes underscore the importance of comprehensive family wealth planning. Here are some steps to consider as you plan your estate:
- Review your estate plan: Ensure your estate plan reflects the latest tax laws, and consider the impact of the 10-year rule on your beneficiaries.
- Communicate with heirs: Discuss the implications of inherited IRAs with your beneficiaries so they are prepared for the financial responsibilities.
- Optimize for tax efficiency: Work with financial and tax advisors to optimize your estate for tax efficiency, potentially leveraging trusts or other vehicles to manage the tax burden.
Navigating the complexities of inherited IRAs and RMDs requires up-to-date knowledge and strategic planning. By understanding the recent changes and consulting with professionals, you can ensure that your wealth transfer is as smooth and tax-efficient as possible, helping your beneficiaries avoid unnecessary financial stress.
For more information or personalized advice, please contact us.
[i] U.S. Retirement Assets: Data In Brief
[ii] Required Minimum Distributions – IRS
[iv] How Do You Name a Minor as Beneficiary of a Retirement Account
[v] Designating a Minor as an IRA Beneficiary
[vi] IRS Allowing Heirs to Skip RMDs
[vii] Step-Up in Basis: Definition, How it Works for Inherited Property
