Plan Ahead to Avoid Headaches with New Rules for Inherited IRAs

The SECURE Act of 2019 created and changed quite a few rules for retirement savings and accounts that may affect you or your family. These changes have gone into effect over several years. One significant change is that beneficiaries are required to take distributions from inherited IRAs much more quickly. Unfortunately, the new rules are confusing, nuanced, and the penalties for failing to comply are severe—planning ahead with the expertise of a skilled financial advisor will be key for those who inherit or expect to make a bequest of IRA funds. Planning and optimizing for the tax impact of inherited IRA distributions, and not running afoul of the IRS, will be more difficult and more important than ever moving forward.

The "death" of the stretch IRA

Historically, beneficiaries of inherited IRAs have been allowed to use their own life expectancy to calculate their required minimum distribution (or “RMD”) each year. This allowed them to withdraw a relatively small amount of the account balance each year and stretch it out over their lifetime. This strategy was often referred to as a “stretch IRA” and gave flexibility to withdraw mostly according to one’s own needs, and hold money in stable, tax-deferred retirement accounts. The SECURE Act eliminated this ability to stretch out distributions for most beneficiaries other than spouses and minor children. Instead, many beneficiaries are now required to withdraw the full balance of an inherited IRA within 10 years. This has been creatively termed the “10-year rule”.

The 10-year rule

Now that Congress has replaced the “stretch” IRA with the 10-year rule, most non-spouse beneficiaries are required to completely empty their inherited IRA accounts within 10 years of the original account owner’s death. While this meant they would have to withdraw the balance more quickly, at least it seemed simple. Unfortunately, Congress left just enough wiggle room for the IRS who later announced that many IRA inheritors would have to BOTH take RMDs based on their own life expectancy AND empty the account within 10 years.

The IRS and Congress want to collect more tax now

You may wonder why Congress made these changes and why the IRS decided to interpret the law in this way. They did it to pull forward billions of dollars in tax revenue. Rather than balances growing tax-deferred in stretch IRAs for decades, many people will now have only 10 years to withdraw the money—and they must pay income tax on those withdrawals.

When RMDs under the new 10-year rule will take effect

The IRS understood that their interpretation was a surprise and that their new rules were somewhat confusing. As such, they have waived penalties for not taking RMDs under the new 10-year rule for the past two years and have now waived penalties for 2024 as well. They provided final guidance on the rule in July 2024, and will begin enforcing the new RMD rule for the first time in 2025. Are you ready? The penalty for failing to take required distributions will be a whopping 25%.

Planning for inherited IRA withdrawals

The condensed 10-year time frame to empty an inherited IRA makes planning important, particularly for those with large balances. Distributions from inherited IRAs are taxable as income. This means that spreading out distributions to avoid jumping into higher tax brackets and coordinating distributions with other changes to income (retirement, one spouse ceasing to work, investment gains, social security, etc.) can help reduce the tax you will owe on distributions. Looking for opportunities to offset “extra income” from distributions by increasing deductible retirement or HSA contributions may also be wise. An experienced advisor is your best option for navigating the new rules, tax-optimizing your 10-year distribution window, and making changes to your retirement plan.

Many owners of existing inherited IRAs are not impacted

Here’s my first piece of advice on the new rules: there’s probably still time to get ahead! These new rules will not impact:

· Those who inherited an IRA from a person who died before January 1, 2020

· Inheriting spouses

· Other select exceptions (minor children, permanently disabled, inheritors that are close in age or older than the original account owner)

This is not an exhaustive overview of the new inherited IRA rules introduced by the SECURE Act. There are additional exceptions and requirements dependent on the age of the deceased, the age of the inheritor relative to the deceased, and whether the deceased was already taking required distributions, for example. Again, the complexity of the new rules, potential tax pitfalls, and severe 25% penalty for failing to take required RMDs make engaging a knowledgeable financial advisor essential for anyone inheriting an IRA moving forward. Please reach out to Grand Wealth Management if you’d like to discuss how these rules may affect you and your family.

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_{Disclosure:
The opinions expressed herein are those of Grand Wealth Management(“GWM”) and are subject to change without notice. This material is not financial advice or an offer to sell any product. This article is for informational purposes only and does not constitute investment, legal or tax advice and should not be used as a substitute for the advice of a professional legal or tax advisor. GWM reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. This is not a recommendation to buy or sell a particular security. GWM is an independent investment adviser registered under the Investment Advisers Act of1940, as amended. Registration does not imply a certain level of skill or training. More information about GWM including our investment strategies, fees and objectives can be found in our ADV Part 2, which is available upon request.}