Final Rulings on The SECURE Act for Inherited Accounts
When the SECURE Act was passed in 2019, a big tax treatment change was set in motion regarding qualified accounts, IRAs, and Roth IRAs. The original stretch treatment for non-spousal beneficiaries became subject to a new 10-year rule. It required most non-spousal beneficiaries to fully deplete the account by December 31, the 10th year following the original account owner's passing.
Before The SECURE Act, beneficiaries of qualifying accounts had a more lenient approach to qualifying inherited accounts. Over their lifetime, they could stretch out distributions of the account based on their age. This was called a stretch treatment.
The 2019 SECURE Act allowed the beneficiary to choose when to take distributions. They could do so anytime between inheriting the account and 10 years after the original account owner's passing.
The beneficiary could choose to take all the money upfront (paying tax immediately).
They could choose to take distributions of any size at any point between inheriting and 10 years (potentially being responsible for smaller tax obligations).
They could choose to leave the funds in a qualifying Inherited account to grow tax-deferred until year 10 and then take one lump distribution (taxable on balance and earnings).
In 2022, following the 2019 rulings, The SECURE Act 2.0 regulations were expanded and the IRS proposed additional regulations deeming Non-Eligible Designated Beneficiaries subject to the 10-year rule coupled with RMDs depending on the original account owners' age before death. At that time the wording was a bit ambiguous. Financial advisors and tax professionals rallied and inundated the IRS with questions seeking clarification of the rules.
On July 18, 2024, the IRS issued a final confirmation of the SECURE Act rules.
Who or what is a Non-Eligible Designated Beneficiary?
In general, Non-Eligible Designated Beneficiaries are anyone who isn’t a surviving spouse and some qualifying trusts.
Since 2022, the big question has been, will RMDs (Required Minimum Distributions) be imposed on Non-Eligible Designated Beneficiaries of inherited retirement accounts?
According to the July 18 confirmation, yes, if the original account owner had begun taking RMDs before death. Non-eligible designated Beneficiaries who inherited retirement, IRA, or Roth IRA accounts must follow suit and continue taking RMDs along with completely distributing the account value by the end of the 10th year after the original owner's death. This is a big switch from original thinking and how advisors and tax pros have been advising clients since the implementation of The SECURE Act.
If the original retirement account owner had not begun taking RMDs, the account must simply be depleted by the end of year 10 after the original owner's passing. The ruling does not impact Eligible Designated Beneficiaries.
Who is an Eligible Designated Beneficiary?
An Eligible Designated Beneficiary includes the surviving spouse, disabled persons, those chronically ill, minor children, certain trusts, and beneficiaries 10 years younger than the deceased.
What if a Non-Eligible Designated Beneficiary has not taken RMDs to date?
Because of the confusing nature of the original 2022 ruling and the enormous outreach of advisors and tax pros, this resulted in the final ruling in July 2024 that provided Non-Eligible Designated Beneficiaries with a break. If they had inherited a retirement account, IRA, or Roth IRA the final ruling does not apply until 2025. In other words, there will be no back-penalties for not having taken RMDs on inherited qualifying accounts; however, the 10-year clock is still ticking.
EXAMPLE 1:
Mary is age 63. She inherited an IRA from her mother in 2023. Her mother was 78 when she passed away and had already begun taking RMDs from her IRA. Mary is considered a non-spouse beneficiary.
The SECURE Act requires that Mary completely deplete the account value by December 31, 2033 (10 years after her mother’s passing). With the newly issued IRS ruling from July 2024, because Mary’s mother had attained the age of RMDs, Mary must also take RMDs on the inherited IRA. Thankfully, Mary will not be penalized for having skipped any RMDs in the years 2023 and 2024, but she will need to take RMDs beginning in 2025.
Let’s consider this from a tax perspective. In 2024, assume Mary is a high earner which for tax purposes lands her in a high tax bracket.
Before the final ruling, she was only required to deplete the account by year 10.
Mary has plans for retirement in 2026 at age 65. Working closely with her financial advisor and tax professional, it was projected that with retirement, Mary’s earned income would drop significantly in 2026. With this in mind, there were plans that Mary would begin taking distributions from her inherited IRA after retirement. She would pay tax on the distributions, but since she would no longer be working she would fall into a lower tax bracket and the distributions would not cause a significant tax impact.
Now with the July 2024 IRS ruling, beginning in 2025, Mary is forced to take RMDs she does not need or want and she could be pushed into an even higher tax bracket. Ouch!
What if there is more than one Non-Eligible Designated Beneficiary?
Often parents leave accounts to their children. There may be easy situations like a parent listing their two kids as 50/50 beneficiaries. However, many account owners can and do title beneficiaries in unequal shares. This opens a whole new mess of scenarios to complicate the situation.
In the year of death, if the original account holder was of the age that stipulated RMDs should be taken, but they had not fulfilled their RMD for the year, it becomes the obligation of the inheriting party to satisfy the RMD.
EXAMPLE 2:
Mary from Example 1, has a sister who was listed with Mary as a 50/50 beneficiary on their mother’s IRA. In the year that Mom passed, she had an RMD obligation of $10,000. She had a habit of taking half of her RMD in March to pay any tax obligations due by the April tax filing deadline. Later in the year, she would take the balance of her RMD in October to pay for an annual vacation and have additional cash left over for gift-giving during December. In 2023, mom passed away in July having only taken $5000 of her $10,000 RMD for the year. Mary and her sister were responsible for taking the $5000 balance of the 2023 RMD.
Were they required to split this RMD 50/50? No, for a variety of reasons, they could have chosen to have paid unequal amounts of the RMD. When a deceased person's assets are divided, siblings often barter over what is important to them and payment of the outstanding RMD could easily have been a negotiation tool.
Are minors required to take RMDs on qualified inherited accounts?
Remember, an Eligible Designated Beneficiary includes the surviving spouse, disabled persons, those chronically ill, minor children, certain trusts, and beneficiaries less than 10 years younger than the deceased. In an in-depth article published by Kitces.com, authors write, “For Eligible Designated Beneficiary purposes, when determining if an individual is a "minor child of the decedent", they will be considered a minor until they reach their 21st birthday.” (Levine & Henry-Moreland, 2024).
Once a minor attains age 21, the 10-year clock begins ticking. Also, the July 2024 rulings stipulate that once a beneficiary is no longer a minor they must take RMDs even if the original account owner had not started taking RMDs! This is a significant difference to how Non-Eligible Designated Beneficiaries are treated.
How the SECURE Act will impact Roth beneficiaries
Roth IRAs and Roth 401(k)s are subject to the 10-year rule. However, as long as the original account owner had established the Roth 5 years before death, all contributions and earnings will come out tax-free to the beneficiary.
The IRS website states, that in “2024 and later years, RMDs are no longer required from designated Roth accounts.” (IRS, 2024).
Conclusion
Financial advisors and tax professionals succeeded in gaining clarification about the SECURE Act rulings. However, the details are technical and should not be reviewed lightly. The most strict rulings apply to non-spouses who inherit. A general rule of thumb is that inherited accounts must be depleted by December 31, of the 10th year after the death of the original account owner. RMDs apply if the original account owner had already begun taking RMDs during their lifetime. Roth accounts are not subject to RMDs.
You do not have to decipher this alone. Lean on your financial advisor (preferably a Certified Financial Planner®) and your tax professional (CPA or EA) to help guide you through the intricacies of the SECURE Act rulings. Determining the timing of distributions is a collaborative process with significant tax implications.
About the Author
Marianne Martini Nolte, CFP® provides tax-savvy wealth management for women and a few cool men.
View our Services & Fees HERE
CLICK HERE to book a free consultation.
Subscribe to the Imagine Financial Services monthly Newsletter HERE.
References
Levine, J., & Henry-Moreland, B. (2024, August 1). IRS new final regulations: 10-year rule, beneficiaries, RMDS. Nerd’s Eye View | Kitces.com. https://www.kitces.com/blog/secure-act-2-0-irs-regulations-rmd-required-minimum-distributions-10-year-rule-eligible-designated-beneficiary-see-through-conduit-trust/
Retirement plan and IRA Required Minimum Distributions FAQs | Internal Revenue Service. (2024, February 28). Retrieved from https://www.irs.gov/retirement-plans/retirement-plan-and-ira-required-minimum-distributions-faqs.
