The original SECURE Act, enacted in December 2019, introduced significant changes to the post-death tax treatment of qualified retirement accounts. Among the most impactful changes was the removal of the “stretch” provision for most non-spouse beneficiaries of pre-tax retirement accounts. You may remember, prior to the SECURE Act, if you inherited an IRA from a parent (for example), you had the ability to “stretch” the required minimum distributions (RMD) over your lifetime. Instead, for most beneficiaries, the SECURE Act enacted a “10-year rule.” This rule mandates that most non-spouse beneficiaries fully distribute inherited retirement accounts within ten years of the original owner’s death.
Before we go deeper, it’s worth noting that the SECURE Act split designated beneficiaries (meaning those individuals or entities inheriting retirement assets) into two new categories: Eligible Designated Beneficiaries and Non-Eligible Designated Beneficiaries. The latter of these two groups (which encompasses most non-spouse beneficiaries) was then made subject to a new 10-year rule. As I said above, the 10-year rule provides that the entire balance of an inherited retirement account must be emptied by December 31st of the 10th year after the owner’s death.
Initially, the financial planning, legal, and accounting community believed that the 10-year rule was meant to replace the previous “stretch” rules for Non-Eligible Designated Beneficiaries. The assumption was that these Non-Eligible Designated Beneficiaries only needed to ensure that the entire retirement account balance was fully distributed by December 31st of the 10th year following the account owner’s death. This meant that if you were a non-spouse beneficiary, you could withdraw any amount you desired in the first nine years if the account was emptied by the end of the tenth year.
However, in early 2022, the IRS released its initial draft regulatory comments on the SECURE Act, adding a curveball: if the original account owner had been taking required minimum distributions (RMDs), the beneficiaries would also need to take annual RMDs during the 10-year period, on top of fully distributing the account by the end of the ten years. This draft IRS proposal was a dramatic shift to the interpretation of the original SECURE Act. Why do we think the IRS proposed such a dramatic shift to their original text in the SECURE Act? Tax revenue! By effectively allowing individuals to punt their tax liability ten years into the future, the IRS gave up a tremendous amount of tax revenue.
However, we now have clarity as of July 19, 2024. The IRS’s new final regulations confirmed the requirement of taking intervening RMDs beginning in 2025 if the original owner was previously taking RMDs. However, for those who “missed” RMDs because of the confusion caused by the legislation from 2021 to 2024, there will be no penalties or need to make up for missed distributions. To clarify this point though, the 10-year clock still starts the year after the decedent’s death, not 2025. Earlier this year, the IRS issued Notice 2024-35, which effectively waived the annual “stretch” RMD requirement during the 10-year rule (for relevant beneficiaries) for 2024. This followed similar guidance issued by the IRS in Notices 2022-53 and 2023-54, which waived the same RMDs in a similar manner for 2021, 2022, and 2023 (remember in 2020 because of COVID relief there was no RMD requirement). Importantly, if you are a Non-Eligible Designated Beneficiary and inherit a retirement account (which in most cases, if you are a non-disabled, non-minor child, this applies to you), and the decedent was younger than RMD age, you do not have to take stretch distributions and are solely held to the 10-year rule. On another note, if you are a Non-Eligible Designated Beneficiary (if you are non-disabled, non-minor child inheriting a deceased parent’s assets), and you inherit a Roth IRA, because Roth IRAs are not subject to RMDs, you are only subject to the 10-year rule for that specific Roth account.
The new regulation effectively starts with intervening RMDs required in 2025 if you inherited a retirement account from a parent who was already taking RMDs (for example). The IRS’s new final regulations are 260 pages long and full of other guidelines as well (which we will dive deeper into later), but for now, let’s close with a few simple examples that largely mirror the concerns of most of our client base:
Example 1: Jonathan (age 58) is the healthy son of David (age 82) who passed away in 2021. David was the owner of a traditional IRA, which was left to Jonathan as a non-spouse beneficiary (in IRS language: Non-Eligible Designated Beneficiary). At the time of his death, David was 82 and subject to required minimum distributions. As a result, Jonathan (the beneficiary) is subject to the 10-year rule AND the annual stretch distributions as well. However, because of the confusion around the legislation, Jonathan has not yet taken any distributions from his inherited IRA. Because of IRS Notices 2022-53, 2023-54, and 2024-35, he will not be subject to any penalty for failing to take his annual stretch RMDs for 2022, 2023, or 2024, nor does he have to make them up. However, going forward, to comply with the rules mandated by the July 2024 final regulations, beginning in 2025, Jonathan must take annual stretch RMDs. In addition, he must fully deplete the inherited IRA by December 31, 2031, the 10th year after his father’s death.
Example 2: Elaine (age 45) is the healthy daughter of Thomas (age 69) who passed away suddenly in 2023. Thomas was the owner of a traditional IRA, which was left to Elaine as a non-spouse beneficiary (in IRS language: Non-Eligible Designated Beneficiary). At the time of his death, Thomas was 69 and therefore, pre-RMD age. As a result, Elaine (the beneficiary) is subject to the 10-year rule only and must deplete the account by December 31, 2033. Therefore, Elaine could take a little each year if she wanted to or take larger sums in certain years (maybe corresponding with lower tax years) or could wait until the 10th calendar year to deplete the account in its entirety without taking any intervening distributions.
Example 3: Greg (age 62) is the healthy son of Theresa (age 83) who passed away in 2021. Theresa was the owner of a traditional IRA and a Roth IRA, which were left to Greg as a non-spouse beneficiary (in IRS language: Non-Eligible Designated Beneficiary). At the time of her death, Theresa was 83 and subject to required minimum distributions from her traditional IRA. As a result, Greg (the beneficiary) is subject to the 10-year rule AND the annual stretch distributions for the inherited traditional IRA and the 10-year rule only for the inherited Roth IRA. Greg has not yet taken any distributions from his inherited traditional IRA. Because of IRS Notices 2022-53, 2023-54, and 2024-35, he will not be subject to any penalty for failing to take his annual stretch RMDs for 2022, 2023, or 2024, nor does he have to make them up. However, going forward, to comply with the rules mandated by the July 2024 final regulations, beginning in 2025, Greg must take annual stretch RMDs from the traditional IRA. In addition, he must fully deplete the traditional inherited IRA by December 31, 2031, the 10th year after his father’s death. With his inherited Roth IRA, he must only satisfy the 10-year rule and ensure the Roth is depleted by December 31, 2031.
