25 Aug IRS Announces Finalized Rule On When Inherited IRA Must Be Distributed – Pay Us Now Or Pay Us Later
The IRS announced its final rule on when an inherited IRA must be distributed to a beneficiary. If the owner of an IRA (or other retirement account) has already reached the date (the Required Beginning Date) when he or she is required to make distributions (70 ½, 72, 73 or 75, depending on date of birth) at the time of the retirement account owner’s death, the beneficiary of the inherited IRA must withdraw at least 1/10 each year beginning with the year after the year of death of the decedent (IRA owner who died) unless the beneficiary is an eligible designated beneficiary described below. If the decedent had not reached the Required Beginning Date when he or she died, then the beneficiary of the inherited IRA has 10 years following the year of death of the decedent IRA owner to make withdrawals although they are not required to make annual withdrawals. For example, if the decedent died at age 68 in year 2024, then the inherited IRA beneficiary does not need to make any withdrawals until year 2034. The positive of delaying IRA withdrawals by the beneficiary until 2034 is the continued tax-deferred growth of the IRA. The negative of delay is when the IRA is distributed, then there will be a large income tax in the year of distribution. This could also lead to higher Medicare Part B and D premiums if the inherited IRA beneficiary is receiving Medicare.
Prior to the passage of the SECURE Act several years ago, the inherited IRA beneficiary could stretch IRA distributions over his or her life expectancy. Those who inherited prior to the law change in 2020 are not affected by this final rule – although the inherited IRA owner still is required to at least make annual distributions over their life expectancy. This results in tax-deferred growth. However, although Congress encourages you save for retirement, it changed the rules so that the government gets its tax dollars quicker (and your beneficiaries cannot take advantage of as much tax-deferred growth).
When the law first passed, many (if not most) thought there would be no requirement of annual distribution (in other words, all could be taken out in the 10th year following the year of death of the decedent/IRA owner since the law was not specific). As a result, many inherited IRA beneficiaries failed to make distributions from the effective date of the law change in 2020 to the present. Due to the confusion, the IRS has indicated it will not penalize those who inherited retirement accounts after the law changed and failed to make distributions in years 2021 through 2024. However, if an inherited IRA owner (other than a ROTH IRA owner) fails to timely make a withdrawal when required, then (starting in year 2025) there will be a 25% excise tax penalty on the amount that should have been withdrawn. If an inherited retirement account owner who inherited the retirement account after the law changed in 2020 has failed to make distributions in years 2021 through 2024, then the owner is required to withdraw an amount based on his or her life expectancy (beginning in year 2025). However, they would still need to take out the full balance of the inherited retirement account by year 10 after the death of the original IRA owner. So, while there would be tax-deferred growth, there could also be a substantial income tax for withdrawing the balance in that final year.
As indicated above, this rule is only applicable if the decedent IRA owner had reached the Required Beginning Date (presently April 1 following the year the IRA owner reaches age 73) when the IRA is inherited. Although the inherited IRA owner must still take withdrawals by the 10th year following the year of death of the decedent IRA owner, the inherited IRA owner might time the distribution to the year when his or her income is expected to drop.
Also if the inherited IRA owner is (1) the surviving spouse; (2) within 10-years of age of the decedent IRA owner; (3) the minor child of the decedent IRA owner; (4) disabled or (5) chronically ill, then they are considered an “eligible designated beneficiary” who can still take advantage of a stretch of the IRA after inheritance as they are not subject to this required rule of withdrawal within 10 years.
Of course with a ROTH IRA, the tax is paid upfront. As a result, there is no required minimum distribution and one who inherits a ROTH must simply withdraw the IRA (generally without taxation) by the 10th year following the year of death of decedent IRA owner.
It is anticipated Congress will continue to make changes to rules regarding retirement accounts.
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