By Matt Cherry, CFP®
Recent inherited IRA tax rule changes are significant. For beneficiaries, what was once a simple process has grown into a complex financial planning strategy. Understanding new rules is crucial to avoiding expensive mistakes and optimizing inherited retirement accounts.
Put simply, the IRS has finalized new rules pertaining to inherited retirement accounts, requiring the majority of heirs to take out a minimum amount each year, with a 10-year deadline to empty the account completely. In the past, heirs could spread out their withdrawals over their lifetime, which permitted larger growth and smaller payouts. But that is no longer allowed.
In this article, I break down the key changes and provide guidance on how to navigate the new rules moving forward.
The SECURE Act’s Impact
Before we dive into the details of the inherited IRA tax rule changes, it’s important to understand the basics of the 2019 SECURE Act and how it affects the way inherited IRAs are handled.
Essentially, the SECURE Act was created to improve retirement savings opportunities for Americans. Important provisions include raising the age at which required minimum distributions (RMDs) must be made, expanding eligibility for retirement aids to part-time employees, and simplifying the process for small firms to provide retirement plans. Specific to this article, it also significantly altered inheritance rules for IRAs.
The SECURE Act required that many inheritors withdraw all money from an inherited IRA account within 10 years but didn’t elucidate if annual withdrawals were necessary. However, the IRS’s final rules now state that yearly RMDs are required for most heirs. The new rules are applicable to both future beneficiaries and those who inherited accounts after 2020, with the exception of spouses.
Before the SECURE Act’s new rules, beneficiaries of IRAs could often stretch out RMD, a strategy known as the “stretch IRA.” The stretch IRA strategy is no longer allowed.
The 10-Year Rule
Now that the stretch IRA is no longer an option, the majority of non-spouse recipients are required to spend down the whole inherited IRA within 10 years of the original owner’s passing.
The distribution method—lump sum, annual withdrawals, or a combination—can be chosen with considerable freedom under this 10-year rule, but it can also result in more tax burdens if withdrawals force the beneficiary into an increased tax bracket. For the distribution strategy to be optimized, careful planning is needed.
Importantly, heirs who didn’t take withdrawals between 2021and 2024 are exempt from penalties, which have been lowered to 25% of the sums that were missing. There is no extension of the 10-year withdrawal period, but heirs are required to begin annual withdrawals by 2025 based on life expectancy calculations. Notably, heirs can postpone taking out money until the last year of the 10-year period if the original account holder has not begun the required withdrawals.
Let’s take a look at how the new 10-year rule affects inherited Roth IRAs.
Inherited Roth IRAs
Inherited Roth IRAs have a special relationship with the new 10-year rule. While traditional IRAs are liable to the 10-year distribution requirement, RMDs are typically not required for Roth IRA owners while they are still alive.
However, it’s crucial to remember that although inherited Roth IRAs are subject to the 10-year rule, annual distributions are not necessary during that time. This is not like standard inherited IRAs, which typically do have RMDs.
Considering the complexity of the new rules, consulting a professional financial advisor is essential. In order to maximize the inherited funds and meet long-term financial objectives, careful planning is necessary.
Reach Out for Help
If you have questions or need further clarification on how the inherited IRA tax rules changes impact your retirement planning, our team is here to help. We can guide you through these changes so you feel confident your retirement plan is optimized.
Our ultimate goal is to earn our clients’ trust each and every day by fully understanding their personal and financial goals, giving unbiased advice, utilizing appropriate investments, and by offering unparalleled service in a comprehensive and timely fashion.
To learn more about our team and the ways we can help guide you, call 480.258.6104 or email adam@ablefinancialgroup.com today.
About Matt
Matt Cherry is a financial advisor at ABLE Financial Group, a financial services practice that focuses on transition planning and simplifying the complexities of their clients’ wealth. Growing up in a world where it seemed debt was part of everyone’s life, Matt found himself following the same path. He soon realized this was not the way he would meet his goals. He worked his way out of debt, and found an interest in how money works. In his late twenties, Matt stepped away from his career to focus on his education.
In 2014, Matt graduated Magna Cum Laude from the WP Carey School of Business at Arizona State University, where he earned a degree in finance. In 2018, he earned the CERTIFIED FINANCIAL PLANNER™ certification. His extensive education and training fed his passion for helping others pursue their investment goals.
Matt spent the first few years of his financial career with Charles Schwab before transitioning to an independent practice. While he is grateful for the education he received along the way, he was excited to join ABLE Financial Group in 2021. As a financial advisor, he gets to do what he loves, helping individuals pursue their investment objectives.
Outside of the office, Matt looks for active ways to help the community. He served as a Big Brother with Valley Big Brothers Big Sisters. Twice, he completed “America’s Most Beautiful Bike Ride,” a 100-mile bicycle ride around Lake Tahoe to raise money for the Leukemia and Lymphoma Society.
Matt is a native to Arizona, currently living in Chandler with his two daughters, Emma and Lyla. Family time is a major priority, taking weekend trips to Mexico, going on a hike, or simply playing games together in the backyard. He was an avid cyclist until a back injury led to surgery in 2017. This is when he found his new passion, yoga. He will attest his daily yoga practice is the main reason he is able to walk today.
