In 2019 Congress passed a law changing the required distribution rules for inherited IRAs in what is called the SECURE Act. These rules apply to all other qualified retirement plans such as 401(k) plans. Before the SECURE Act distributions from inherited retirement accounts could be spread over a beneficiary’s life expectancy (known as the Stretch IRA).
The SECURE Act ended the Stretch IRA for the vast majority of taxpayers requiring the assets in an IRA to be paid out on or before December 31st of the tenth calendar year following the death of the IRA owner (the “10-Year Rule”). The 10-Year Rule applies to inherited IRAs from an IRA owner who died after 2019. Inherited IRAs before 2020 still benefit from the Stretch IRA rules.
An exception to the 10-Year Rule applies where the IRA is left for one or more certain beneficiaries known as “Eligible Designated Beneficiaries” who generally can qualify for the lifetime payout that applies in a manner similar to Stretch IRA. Eligible Designated Beneficiaries include the IRA Owner’s surviving spouse, the IRA Owner’s minor children, a disabled or chronically ill beneficiary, or a beneficiary who is no more than 10 years younger than the IRA Owner. However, an IRA that is left for a non-Eligible Designated Beneficiary must meet the 10-Year Rule.
Prior to the IRS issuing proposed regulations in February 2022, it is safe to say all tax professionals interpreted the SECURE Act to mean that the 10-Year Rule did not require annual distributions (required minimum distributions or RMDs). We concluded a beneficiary could take distributions at any time during the 10-year period as long as the IRA assets were fully distributed by December 31st of the tenth calendar year following the death of the IRA owner.
The proposed regulations surprisingly require annual RMDs and then the inherited IRA must be totally distributed by December 31st of the tenth calendar year following the IRA owner’s death. For example, if an IRA owner died June 10, 2020, after having begun RMDs, the IRA beneficiary of the inherited IRA was required to receive an RMD starting in 2021 and each year thereafter and all remaining assets of the IRA must be distributed by December 31, 2031.
Many beneficiaries of inherited IRAs subject to the 10-Year Rule did not take RMDs out in 2021 and 2022. The penalty for not meeting the RMD requirements is 50% of the amount required to be distributed. The IRS just announced that no penalties will apply for the failure to take RMDs subject to the new rules in 2021 and 2022. The penalty for not taking RMDs from an inherited IRA will first apply for the 2023 year.
There is no indication the IRS will allow those who did take RMDs in 2021 and 2022 from an inherited IRA subject to the 10-Year Rule to repay those RMDs and claim a refund for 2021 or reduce their 2022 taxes. However, a beneficiary of an inherited IRA subject to the 10-Year Rule who received an RMD in 2022 can put it back in the IRA within 60 days of receipt and avoid paying tax on the RMD in 2022.
The RMD rules have become too complicated and require an understanding of all the subtle facets of the rules to ensure the best result. Please contact a member of the HBK team to discuss your specific circumstances.