The IRS has issued final regulations for handling inherited Individual Retirement Accounts (IRAs) and required distributions for account beneficiaries. IRAs inherited pre- and post-2020 follow different conventions and require a keen understanding of the nuances to distribute properly. Due to long-awaited clarification, the IRS is suspending the requirement for 2024 distributions from inherited IRAs for certain individuals.  

IRAs enable tax-deferred savings for retirement by allowing an individual to contribute pre-tax earnings to an account and grow them tax-deferred. In exchange for deferring taxes, the IRS receives taxes upon withdrawal, which are required once an individual reaches the appropriate age (70½ for those born 6/30/1949 or earlier, 72 for those born 7/1/1949 to 1950, 73 for those born 1951 to 1959, or 75 for those born after 1960). Planning Tip: To avoid costly and time-consuming probate requirements, account holders should list beneficiaries on their IRAs for smooth and immediate distribution after their passing.  

The recent IRS rulings add further clarification for distributing inherited IRAs. The rules for inherited IRAs differ substantially depending on your relationship to the account holder, the account holder's age, your age relative to the account holder, the year of passing, and whether the account holder had begun required minimum distributions (RMDs). Below is an overview of the IRS requirements for inherited IRAs. 

Sole Spouse Beneficiary

The rules are relatively simple when a spouse is the sole beneficiary of an inherited IRA. In this case spouses can treat it as their own, treat themselves as the beneficiary, or even roll it into their existing IRAs. Once the IRA is in the spouse's name, the IRA follows the same rules as a traditional IRA (i.e., it no longer needs to behave as an inherited IRA).  

Non-Spouse Beneficiary

IRAs Inherited Before January 1, 2020 (pre-SECURE 2.0 Act) 

If an IRA was inherited before 2020 and prior to the original owner beginning RMDs (or reaching his or her required beginning date – April 1st of the year after the deceased would have reached RMD age), the beneficiary can extend distributions over the beneficiary’s lifetime or, less commonly, elect to take distributions over either the five years following the owner's death or in a lump sum in the fifth year. We would suggest following whichever approach you have in place in consultation with your tax advisor.  

If an IRA was inherited before 2020 and after the original owner had already begun taking RMDs, the beneficiary must take RMDs each year based on the longer of either the original owner's life expectancy or the beneficiary's life expectancy. If the deceased did not take the RMD for the year in which he or she died, the beneficiary must take that amount in the current year.

Visually, you can use the flow chart below to understand the rules:

 

IRAs Inherited After January 1, 2020

Most beneficiaries of IRAs who inherited the account beginning in 2020 will be required to distribute the account within ten years.  

If the deceased had begun taking RMDs (or reached his or her required beginning date – April 1st of the year after the deceased would have reached RMD age), annual payouts, based on the longer of the beneficiary or the deceased’s life expectancy, must begin in the year after death and are required for ten years, by which the full account will have been distributed. If the beneficiary inherited the account between 2020 and 2024, he or she will not be penalized for not taking RMDs during those years. RMDs must begin in 2025, and the ten-year clock still begins from the date of death.

If the deceased had not begun taking RMDs, the beneficiary can take the funds out at any time during the ten-year period – including waiting until the 10th year to distribute the account in full.

Notably, the requirements for certain beneficiaries changed with recent updates: If the inherited IRA owner is deemed an eligible designated beneficiary, i.e., the spouse or minor child (under age 21) of the deceased, an individual less than ten years younger than the deceased, or an individual who is chronically ill or disabled, he or she is not subject to the ten-year distribution rule. An eligible designated beneficiary can take annual payouts based on the beneficiary’s life expectancy. If the original owner was required to take an RMD in the year of passing and did not, the beneficiary must take the RMD.

Here is a quick overview of how to determine what you should consider related to an IRA inherited after January 1, 2020:

 

* If the original owner was required to take an RMD in the year of passing and did not, the beneficiary must take the RMD.
** If the beneficiary inherited the account between 2020 and 2024, he or she will not be penalized for not taking RMDs during those years.                However, RMDs must begin in 2025, and the 10-year clock still begins from the date of death. 

 

You can read more about considerations related to Inherited IRAs on osterweisprivateclient.com. As always, the Osterweis Private Client Team is here to help simplify complexities like this and develop a plan tailored to your specific tax and cash flow situation. Furthermore, Trump-era tax cuts are set to expire after 2025, so there are rare tax planning opportunities unique to 2024 and 2025 that you should consider, especially if you are planning to retire soon or recently received an inherited IRA. We would be happy to set up a time to discuss any financial concerns weighing on your mind.

Christopher Zand, J.D., CFP^®

Vice President & Director of Private Client

Natalie Belyea

Private Client Advisor