Retirement Planning and IRAs

Hard-working Americans spend a lifetime trying to obtain financial stability and to then provide a financial legacy for their families. Often, the strategy to achieve such goals involves the funding of individual retirement accounts (IRAs). Despite working many years to build the balances of these accounts, the IRS does not allow the owner of an IRA to keep retirement funds in an IRA indefinitely. Eventually, the IRS requires the owner of an IRA to start making withdrawals from their account. These required withdrawals are known as required minimum distributions (RMDs) which generally must be taken by April first, after turning 72 years of age (73 after December 31, 2022).

Inheritance and IRA Rules

Upon the death of the owner of an IRA, the remaining balance of the IRA passes to the owner’s designated beneficiaries; if none, then to his or her estate. Traditionally, beneficiaries of an IRA could “stretch” withdrawals from an inherited IRA over their expected lifetime, likely reducing year-to-year tax liability.

Changes in IRA Rules: SECURE Act and SECURE 2.0 Act

However, Congress changed those stretch rules in December of 2019 when the SECURE Act was passed. Although a surviving spouse beneficiary still has the lifetime stretch, most other beneficiaries of an inherited IRA must now fully exhaust the account within 10 years of the death of the IRA owner or 10 years from the date the beneficiary turns 18.

Then again, in December 2022, Congress complicated the new 10-year rule when it passed the SECURE 2.0 Act just two years later. The SECURE 2.0 Act added the requirement that if the original IRA owner had already started taking required minimum distributions, then the new owners of the now Inherited IRA must also take RMDs. Failure to do so, would result in penalties to the beneficial owner of the inherited IRA. This new rule resulted in confusion. Consequently, amid mounting questions, the IRS issued Notice 2022-53 in October of 2022, which waived such penalties for not taking the RMDs from inherited IRAs until 2023.

Recent IRS Guidance and Impact

Now, the IRS has issued Notice 2024-35, which again delays any penalty for not taking the RMDs in 2024 from IRAs inherited in 2023. So, with this new guidance plus the previous relief from the IRS, penalties are waived for missed RMDs from IRAs inherited from 2020 through 2023.

Considerations for Beneficiaries

While the grace period has been extended, beneficiaries of inherited IRAs, who are subject to the 10-year rule, should proceed with caution. Nothing in the latest guidance from the IRS suggests that the RMD requirements imposed by the SECURE 2.0 Act will be removed entirely. Additionally, nothing in the latest IRS guidance suggests that the SECURE Act’s 10 year rule will be abolished. As a result, any delay of taking RMDs by an owner of an inherited IRA may force a beneficiary to take higher RMDs in the final years of the 10-year period. These compounding distributions may cause the beneficiary a higher income tax liability. The increased RMDs may result in a higher tax bracket for the beneficiary, this is particularly likely for a beneficiary who is not planning to retire within the 10-year window. Further, individual income tax rates are likely to increase over time with the reduction in the individual income tax rates from the Tax Cuts and Jobs Act passed in 2017 set to sunset on December 31, 2025.