The final regulations provide clarity regarding inherited IRA withdrawals and eligibility requirements.
Getty
The IRS has issued further guidance on required minimum distribution (RMD) rules, this time in the form of a final rule.
of Final Rule Clarify inherited IRA withdrawals and eligibility requirements.
RMD
By law, you are required to withdraw money from your retirement accounts each year after you reach age 73 (rising to 75 in 2033). The amount you withdraw is called a Required Minimum Distribution (RMD). Typically, the amount you must withdraw each year is calculated by dividing the account balance at the end of the previous year by your life expectancy. The life expectancy factor is: IRS Publication 590-B.
Inherited IRA
However, if you inherit a retirement account, the rules are a little different and are made stricter by the SECURE Act.
Before the SECURE Act, if you inherited a retirement account, you could minimize the tax impact by taking distributions over your life expectancy. Under the new rules, if you inherit a retirement account, you can either take the entire amount in one lump sum or take it over 10 years. This rule is aptly called the “10-year RMD rule.”
The rules are complicated, but in general, the 10-year RMD rule requires that all assets in an inherited IRA be withdrawn in full by the 10th year after the death of the original IRA owner. (For minor child beneficiaries, the 10-year RMD rule applies once they reach the age of majority.) This sounds simple, but it created confusion. Some beneficiaries interpreted this language to mean that they could wait until the end of the 10-year period to withdraw the full amount, meaning they didn’t have to make regular withdrawals every year for 10 years. After all, this was consistent with the old 5-year rule for certain inherited IRAs.
However, the IRS previously indicated that if the original participant had already begun taking RMDs, they would be required to take RMDs annually, which was a problem for beneficiaries who inherited IRAs after the SECURE Act was enacted and had not received required distributions.
Skipping RMDs is a costly mistake: Penalties can be up to 25% of the amount by which your RMD in a year exceeds the amount distributed that year.
history
In 2022, the IRS Notice 2022-53 Under the proposed regulations, a beneficiary subject to the 10-year RMD rules would have to continue to take annual distributions after the IRA owner’s death, and total distributions would have to be made no later than 10 years after the year of death.
In the 2022 Notice, the IRS also provided transitional provisions. Specifically, if a taxpayer did not take certain RMDs in 2021 or 2022 related to an inherited IRA, the IRS agreed not to assess additional (excise) tax or penalties on those amounts in 2022. Also, taxpayers who paid tax on unpaid (related) RMDs can claim a refund.
The following year, the I.R.S. Notice 2023-54This added relief by waiving the missed RMD payments related to inherited IRAs in 2023. The notice also announced that the final rules will not apply earlier than the 2024 calendar year of distribution.
Recently, the I.R.S. Notice 2024-35extends the relief through 2024, as you might expect, and clarifies that the final regulations will not apply earlier than the calendar year of distribution in 2025. This relief applies to RMDs required if the IRA owner dies in 2020, 2021, 2022, or 2023 on or after the IRA owner’s required beginning date.
Final Rule
The final regulations confirm the general guidelines of the proposed regulations, namely, that distributions to beneficiaries must be made “at least as promptly” as they would be made while the beneficiary was alive, and full distributions must be made within 10 years.
When talking about inherited IRAs, you may often hear about the “at least as fast” rule. This rule emphasizes the frequency of withdrawals, not the amount of withdrawals. Here, it means that if the original IRA owner dies after distributions have begun based on life expectancy rules, the remaining amount must be distributed at least as fast as the method used.
However, if the original IRA owner dies before the RMD begins, the interest must be distributed within five years of death or over the life or life expectancy of the designated beneficiary, and distributions generally begin within one year of the date of death.
Eligible Beneficiaries
The final regulations also clarify the treatment of qualified beneficiaries. Certain beneficiaries, known as qualified beneficiaries, are exempt from the 10-year RMD rule. Qualified beneficiaries include the IRA owner’s surviving spouse and children under age 21, disabled and chronically ill individuals, and people within 10 years of the account owner.
(Note that self-certification of a disability or chronic illness is not sufficient, as the final rule requires documentation.)
If the original account holder had not started taking RMDs, the eligible beneficiary may choose to take them based on his or her life expectancy or the 10-year rule. If the original account holder had taken RMDs before death, the eligible beneficiary may choose to take them based on either his or her life expectancy or the participant’s life expectancy, whichever is longer.
Eligible recipients under the age of 21 are given hybrid treatment, meaning the 10-year rule does not apply until they turn 21.
Those who are not eligible to receive benefits
Non-qualified beneficiaries, that is, anyone who is not a qualified beneficiary (usually an adult child or grandchild of a plan participant), are subject to the 10-year rule.
Trust as Beneficiary
The final regulations also retain the see-through trust concept from the 2002 final regulations. To be a see-through trust, a trust must meet the following criteria:
- The trust is valid under state law, or would be valid except for the fact that no trust property exists.
- The trust may be irrevocable or, by its terms, may become irrevocable upon the employee’s death.
- The trust beneficiaries who are the beneficiaries of the trust’s interest in the employees’ interests are identifiable.
- The specified documentation requirements are met.
(As with much of tax and trust law, these rules are very specific, and exceptions and special treatment may apply depending on the situation.)
effective date
The final regulations apply to calendar years beginning after January 1, 2025. For prior years, taxpayers must apply the 2002 and 2004 final regulations and IRS notices “taking into account a reasonable and good faith interpretation of the amendments made by sections 114 and 401 of the SECURE Act.”
advice
The rules surrounding RMDs can be complicated, especially with the changes in the SECURE Act and SECURE 2.0 Act. Making mistakes can be costly. Check with a tax or financial professional if you have questions.
(Procedural note: These final rules have not yet been published as of this writing. Published Published in the Federal Register on July 19, 2024.
