In 2020, The SECURE Act changed the IRA inheritance landscape – terrain that would shift again in 2022 with the passage of the SECURE Act 2.0. Over the summer, that new ground was firmed up as the IRS finalized regulations that will go into effect January 1, 2025. Here’s a look at the rules and how they could impact your wealth and wealth transfer planning.
One of the biggest changes brought by the original SECURE Act was the introduction of the “10-year rule” for designated beneficiaries, which sought to stem the amount of time inherited money could grow tax-free.
Implemented in January 2020, the 10-year rule requires most non-spouse beneficiaries to withdraw the entire balance of an inherited IRA within 10 years. It also set parameters around timing, distributions and beneficiary categories.
Required with some exceptions, that the entire balance of an inherited retirement account be distributed within 10 years of the owner’s death; raised the age when RMDs must be taken:
RMDs begin at 72 for those born between July 1, 1949 and 1950.
Maintained the 10-year rule; further raised the age at which RMDs must be taken:
RMDs begin at 73 for those born between 1951 and 1959
and at 75 for those born after 1960.
The minimum amount that must be withdrawn from a retirement account each year after the account owner reaches the designated age.
The date by/on which the first RMD must be taken. This date is April 1 of the year after an IRA owner reaches their applicable RMD start age (currently 73).
Beneficiaries who may take distributions over their life expectancy – but may also choose to apply the 10-year rule, depending on their situation, including:
Beneficiaries who are subject to the 10-year rule, including:
“The changes will have the biggest impact for beneficiaries of larger accounts, further exacerbated if those beneficiaries are successful themselves and taxed at higher rates. This compressed time period could force distributions into higher taxer brackets,” said Jim Kidney, CPA®, CPWA®, who supervises the financial planning consulting practice at Raymond James. “Before the 10-year rule, the ‘stretch IRA’ strategy enabled inheritors to spread distributions – and the tax impact – across their life expectancies.”
While that possibility is much more limited now, there are alternative strategies for maximizing IRA funds in line with current regulations.
Converting a traditional IRA to a Roth IRA before an account owner reaches their RBD can keep those converted dollars at a lower tax bracket compared to if they were forced to take it as an RMD from the Traditional IRA later. Furthermore, the converted dollars and associated earnings will be tax free to the owner and ultimately to a beneficiary, provided several conditions are met.
A somewhat more involved planning strategy is to consider using distributions from a pre-tax retirement account to purchase life insurance, allowing the policy holder to name as beneficiary the same person they intended to inherit their retirement account.
The finer points of how a beneficiary inherits an account will impact how the 10-year rule is applied and how RMDs are managed.
If the account owner dies before their RBD:
A non-eligible beneficiary will need to deplete the account by December 31 of the tenth year following the owner’s death but will not have to take RMDs.
If the account owner dies after their RBD:
A non-eligible designated beneficiary will need to take RMDs in years one through nine, with a final distribution in year 10. This RMD requirement is generally based on the single life expectancy of the beneficiary.
Because final guidance regarding the 10-year rule has been shared four years after the rule’s introduction, some beneficiaries could have needed to take RMDs in the intervening period. In many of these cases, the IRS is issuing waivers for missed RMDs. This waiver only applies to non-eligible designated beneficiaries under the 10-year rule who inherited from an IRA owner who died after their RBD.
For beneficiaries in high tax brackets, it’s important to weigh strategic timing options for distribution. For example, if a beneficiary plans to retire five years after inheriting, it may be most efficient to take minimum distributions while they’re still working and increase payments to deplete the account in their first five years of retirement.
While this rule is settled, the climate is sure to change again, inviting new tax and financial planning implications. To keep your footing, work closely with your financial advisor and, when appropriate, experienced estate planning and tax professionals.
This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Raymond James does not provide tax or legal advice. Please discuss these matters with the appropriate professional. Withdrawals from tax-deferred accounts may be subject to income taxes, and prior to age 59.5 a 10% federal penalty tax may apply.
Rolling from a traditional IRA into a Roth IRA may involve additional taxation. When converted to a Roth, you pay federal income taxes on the converted amount, but no further taxes in the future. Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Each converted amount is subject to its own five-year holding period, unless the owner is 59.5 or older.
Investments & Wealth Institute™ (The Institute) is the owner of the certification marks “CPWA®” and “Certified Private Wealth Advisor®.” Use of CPWA and/or Certified Private Wealth Advisor signifies that the user has successfully completed The Institute’s initial and ongoing credentialing requirements for investment management professionals.
