When you inherit an Individual Retirement Account (IRA) or other type of retirement account, you're faced with a set of rules dictating the minimum amounts you must withdraw annually. These are Required Minimum Distributions (RMDs), and they have significant implications for how much tax you'll pay and how you can manage the inherited funds over time.
The “Setting Every Community Up for Retirement Enhancement” (SECURE) Act, signed into law in December 2019, marked a significant shift in how these distributions are handled. And the changes have only continued.
In this article, we look at these changes and what they mean to you.
The era of the stretch IRA
Before 2020, beneficiaries could benefit from what was known as the “stretch IRA” provision. This allowed non-spouse beneficiaries to “stretch” the distributions – and the tax obligations – over their own lifetimes. This approach allowed for potentially decades of continued growth without immediate tax implications.
The SECURE Act and initial misunderstandings
All that changed with the arrival of the SECURE Act in January 2020. Under the new guidelines, these beneficiaries were now subject to a 10-year rule that stipulated that the entire balance of an inherited IRA had to be withdrawn within 10 years following the account holder's death.
The introduction of the 10-year rule brought a wave of misunderstandings and confusion. One widespread misconception was the belief that beneficiaries had the flexibility to choose not to take any distributions until the very end of this 10-year period. Many thought that the distribution schedule within that timeframe was entirely at their discretion as long as the entire account was emptied by the deadline. This misunderstanding stemmed from a lack of clarity in the initial guidance and widespread speculation about how the rules would be enforced.
(The SECURE Act did carve out an exception for eligible designated beneficiaries: minors, disabled people, the chronically ill, and individuals less than 10 years younger than the IRA owner can still stretch the IRA distributions over their lifetime.)
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More changes adds to more confusion
The IRS then dropped a bombshell in February 2022 that required non-eligible designated beneficiaries to take distributions throughout the 10-year period, not just at its conclusion.
Specifically, the IRS’s new stance was that if the original account holder was subject to RMDs at the time of their death, then the non-eligible beneficiaries would need to take yearly distributions based on their own life expectancies. Calculating these annual distributions involved using the IRS’s Uniform Lifetime Table to determine the beneficiary’s life expectancy, then reducing that figure by one each year.