Just four years ago, the Stretch IRA estate planning strategy allowed an original IRA owner to pass their IRA to a non-spouse beneficiary, who could extend the tax-deferred benefits through an Inherited IRA over their lifetime, essentially stretching the IRA benefits over two lifetimes. Those days are no longer! The SECURE Act of 2020 eliminated the Stretch IRA strategy, forcing Non-Eligible Designated Beneficiaries (NEDB) to completely withdraw the inherited retirement account by the end of the 10th year anniversary of the original IRA owner’s passing. In other words, an Inherited IRA could only benefit from tax-deferral for 10-years, limiting the benefit period, and possibly increasing the tax liability to the beneficiary. Non-Eligible Designated Beneficiaries (what a mouthful!) are beneficiaries who are neither the original IRA owner’s spouse, nor do they fall into limited categories (i.e.: minor child of the deceased, disabled person, individual not more than ten years younger than the original account owner, etc.) that would allow for more beneficial IRA inheritance treatment.[i]
Upon issuance of the SECURE Act of 2020, many understood the rule to replace the Stretch IRA benefit with a 10-year window, at which time the IRA must be fully distributed. At onset, there was no mention that the Inherited IRA beneficiary would need to take annual Required Minimum Distributions (RMDs) during years one through ten following the original owner’s death. However, in February 2022, the IRS issued Proposed Regulations that would segment beneficiaries into categories with distinct distribution rules. One of those groups were beneficiaries who inherited an IRA from an owner who died on or after their Required Beginning Date (RBD), or the date in which they needed to start taking Required Minimum Distributions (RMDs). Historically, the Required Beginning Date had been age 70 ½, but that changed under the SECURE Act to age 72 as of 2020. Further, SECURE Act 2.0 (passed December 2022, effective in 2023) pushed the RMD age back again to age 73 for those born between 1951 and 1959, and to age 75 for those born in 1960 or later.[ii] Circling back, per the IRS 2022 Proposed Regulations, beneficiaries who inherited an IRA from an owner past their RBD would be subject to both the 10-year distribution rule, and would now also be responsible for taking annual RMDs during years one through ten. The difficulty was that the IRS issued the Proposed Regulations in February 2022, two years after the SECURE Act of 2020 was passed, such that many in the affected group had not taken annual RMDs. The IRS issued a notice in October 2022 waiving any potential penalties for Non-Eligible Designated Beneficiaries who missed Inherited IRA RMDs in 2021 and 2022, effectively eliminating RMDs for those two years, but still failing to address the RMD parameters for 2023 and years thereafter. Further, in July 2023, the IRS released Notice 2023-54 which eliminated penalties for failing to take RMDs for 2023, but finalized that the 10-year distribution rules would be applicable for the calendar year 2024+. Hopefully by the time 2024 Inherited IRA RMDs are due, the IRS will have clarified the Final Regulations for Non-Eligible Designated Beneficiaries who inherited retirement accounts from an owner who died on or after their Required Beginning Date.
Under the new IRA distribution rules, Non-Eligible Designated Beneficiaries should be mindful of the income tax that will be due on the Inherited IRA distributions. Under the old Stretch IRA rules, a Non-Eligible Designated Beneficiary was able to take a small RMD based on their own life expectancy. In many cases, that could be a small distribution of about 3% of the IRA balance annually. That means the beneficiary was able to take a minimal distribution annually to satisfy the IRS requirement and likely maintain their income tax rate. Under the new SECURE Act rules, a beneficiary has to take a full IRA distribution at the 10th year, and some select groups must also take an annual RMD during years one through ten of the distribution window.
To spread out the income tax on the IRA distributions, a beneficiary may want to consider withdrawing an even 10% of the original account balance annually. Spreading out the taxable income may advert being pushed into a higher tax bracket. However, even when utilizing this strategy, the 10-year distribution rule could cause the beneficiary of an inherited IRA to take distributions that are more than three times larger than what would have been required under the old Stretch IRA rules, making the IRS as a larger beneficiary than intended. For this reason, despite the IRS’ pending finalization of Inherited IRA RMD rules, it may be in the beneficiary’s best interest to consider taking annual RMDs in years one through nine to avoid a large lump sum distribution in year 10 that could push the beneficiary into a very high tax bracket.
Non-Designated Beneficiaries, such as charities and estates, must continue to fully withdraw the balance of an IRA gifted by the end of the fifth year anniversary of the original owner’s passing, if the decedent was younger than their Required Beginning Date. If the original IRA owner passed away on or after their Required Beginning Date, the charity or estate would need to take annual distributions or RMDs for years one through five. That rule was unchanged under the SECURE Act of 2020 and SECURE Act 2.0 of 2022.
In summary, the Stretch IRA is dead. Non-spousal beneficiaries need to distribute IRAs in full by the tenth year. If a NEDB inherits an IRA after the decedent’s RBD, they must adhere to the new 10-year distribution rule and take RMDs for years one through nine with full distribution in year 10, starting in 2024.
Keeping up with the ever changing tax landscape can be burdensome. If tax code isn’t your pleasure reading, consider hiring a team of advisors who can dissect the tax law and bring relevant information to your attention timely. A Certified Financial Planner™ or CPA with a Personal Financial Specialist credential can work with your accountant and attorney to ensure you are taking advantage of any opportunities available, and avoid unnecessary excise tax penalties.
[i] https://www.irs.gov/publications/p590b
[ii] https://www.irs.gov/retirement-plans/retirement-plan-and-ira-required-minimum-distributions-faqs