Have you ever heard of Rube Goldberg machines? Rube Goldberg was a cartoonist known for drawing overly complex machines that performed simple tasks — a fitting metaphor for post-SECURE Act inherited RMD rules. In case you’re not familiar with Required Minimum Distributions (RMDs), these are annual life-expectancy based withdrawals the IRS requires you to take from traditional IRAs upon reaching a certain age (70.5-75 depending on birth year) for IRA owners, or upon inheriting a traditional IRA for certain beneficiaries.
We’ve entered the era of the “Great Wealth Transfer.” Baby boomers (born 1946 – 1964) are the wealthiest generation by far, and it’s estimated that $100 trillion will be transferred to heirs by 2048. The average age of those inheriting this wealth is 51- often their peak-earning years and highest tax brackets. It’s no surprise that the Secure Act eliminated “stretch” IRA provisions (stretch meaning distributions can be spread over lifetime), requiring most non-spouse beneficiaries to fully distribute inherited IRAs within 10 years (the 10-year rule). This change accelerates tax revenue for the government, especially with inherited traditional IRAs.
The IRS admitted that the language in Secure Act 1.0 did not clearly explain its complex rules and has since provided clarifications and temporary relief. The excise tax penalty for not making timely withdrawals was waived from 2021- 2024 while we all figured how to apply the new, confusing rules. That grace period has come to an end, so let’s dive into the high-level aftermath of this legislation. There’s no way to cover every situation, so I’ll focus on the most common ones here.
First, when inheriting a traditional or Roth IRA, a non-spouse beneficiary must answer a few very important questions:
- Did the IRA owner die before or after 12/31/2019?
- Was the IRA owner subject to Required Minimum Distributions (RMDs)?
- What category does the beneficiary fall into – Non-designated Beneficiary, Designated Beneficiary, or Eligible Designated Beneficiary (EDB)?
- Is the beneficiary a successor beneficiary (inherited an IRA from a beneficiary)?
If the IRA owner died after 12/31/2019, the new Secure Act rules apply. The next step is to determine if the owner was subject to RMDs meaning he or she died after RMD start date. If so, annual RMDs will be required for inherited traditional IRAs and in many cases, this will be in addition to the 5 or 10-year rule. An important distinction is that since Roth IRA owners are not subject to RMDs during their lifetime, IRS guidance treats Roth owners as having died before their required start date for purposes of determining inherited IRA rules and therefore inherited Roths are not subject to annual RMDs but are subject to the 10-year rule.
In answering the third question, an important point to make is that the Secure Act introduced a new category of beneficiaries, Eligible Designated Beneficiaries, who can generally elect stretch distributions if they choose. Here are the 5 types of EDBs: surviving spouse, minor child of account owner, disabled, chronically ill or not more than 10 years younger than the account owner (i.e. a sibling). For minor children, after reaching the age of majority, the 10-year clock does start ticking and the account must be distributed by the end of the 10th year.
A named individual beneficiary that does not meet the EDB requirements is considered a Designated Beneficiary (i.e. adult children). Non-designated beneficiaries are non-person beneficiaries without a life expectancy such as an estate, charity and some trusts.
I’d say the most straightforward rules are for non-designated (non-person) beneficiaries. If the owner died before RMDs were required, the account must be fully distributed within 5 years. If the owner died on or after the RMD start date, distributions follow the decedent’s remaining life expectancy per the IRS Single Life Expectancy table. If it seems bizarre to refer to the life expectancy of someone who has passed away, it is, but it’s the terminology the IRS uses.
The definition of Eligible Designated Beneficiaries was the source of much of the confusion that led to clarification from the IRS. If you meet the requirements for this category and the owner died before the RMD start date, you have the choice of taking annual distributions over your lifetime or the 10-year rule. If the owner died after the RMD start date, required distributions are calculated based on the longer of the Eligible Designated Beneficiary’s life expectancy or the decedent’s remaining life expectancy. As the spouse, you do still have the option to roll the account into your own IRA. Under this method, you will use the Uniform Lifetime table which results in lower RMDs than the Single Life Expectancy table used for inherited IRAs. For spouses under 59 ½, it may be advantageous to select the inherited IRA verses the rollover if you plan to take withdrawals before age 73 (or 75 if born 1960 or later).
Now we’ll tackle the most common category, Designated Beneficiaries, who are people that do not meet the EDB requirements. If the owner dies before the RMD start date, Designated Beneficiaries are subject to the 10- year rule only and there are no required annual withdrawals. If the owner died on or after the RMD start date, the beneficiary is subject to the 10-year rule and additionally must take annual withdrawals calculated based on the beneficiary’s life expectancy per the Single Life table beginning the year after death.
There’s another situation worth mentioning, successor beneficiaries. A successor beneficiary inherits an IRA from the original (first-generation) beneficiary. Rules depend on when both the original owner and the first beneficiary died. In general, successor beneficiaries cannot use the life expectancy method and are subject to the 10-year rule, but when the 10-year clock starts can be complicated and requires a deeper look at the rules. If the original beneficiary was an EDB using life expectancy, the successor gets a new 10-year clock, but if original beneficiary was under the10-year rule, the successor must finish out the original 10 years.
This was a lot to throw at you! I went to a 3-hour seminar on post Secure Act RMDs and used the 79-page pdf handout as a reference for this memo – which gives you an idea of how complex these rules really are. We haven’t even touched on tax planning or distribution strategies for navigating the 10-year rule – that’s a topic for another day. In the meantime, feel free to reach out to me with any questions you may have.
