Written By: Fairvoy Private Wealth, LLC.
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On July 19, 2024, the Department of the Treasury, Internal Revenue Service, issued its final rules regarding Required Minimum Distributions, or RMDs. The rules apply to RMDs in the calendar year on or after January 1, 2025. RMDs are familiar to many individuals over the age of 73 who own tax-deferred accounts, such as IRAs. Each year, owners of these qualified accounts must take a mandated yearly withdrawal from accounts, such as IRAs, 401(k)s, and other tax deferred retirement plans. For most clients of Fairvoy Private Wealth, these final rules are of particular importance to retirement accounts that are inherited by children of those we serve.
Understanding the New SECURE Act Rules for Inherited Retirement Accounts
Following the passage of the SECURE Act and the SECURE Act 2.0, there were multiple changes that impacted how quickly a retirement account would need to be liquidated. Prior to the passage of the SECURE Act, non-spouse beneficiaries could “stretch” distributions over their life, essentially spreading the tax liability over many years. Since the SECURE act passage, the distribution period is generally limited to 10 years, with some exceptions such as for a spouse or minor children. There was some confusion as to whether individuals could defer distributions until the 10th year or if they were required to take distributions in years 1 through 9. These final rules were meant to clear up some confusion, but as you will see, there are a maze of options.
Under the final rules, most non-spouse beneficiaries will be required to take an annual minimum distribution in each year until final liquidation by the end of the 10th year. This distribution rule applies to accounts such as IRA/401K accounts and Roth IRA accounts (there are generally no taxes due on the Roth distributions). While these rules apply to most inherited retirement accounts, there are some exceptions: surviving spouses, minor children, disabled, chronically ill individuals or any individual that is not more than 10 years younger than the IRA owner, may not have to follow the ten-year rule.
Two Key Questions Beneficiaries Should Ask to Understand Which SECURE Rules Apply
- What type of beneficiary is listed?
- Designated Beneficiary: An individual named specifically by the account owner, such as a spouse, child, or another person. Additionally, is the designated beneficiary an Eligible Designated Beneficiary or Non-Eligible Designed Beneficiary (Table)
- Non-Designated Beneficiary: An entity or situation where no specific individual is named, such as an estate, charity, or certain types of trusts.
- Did the decedent pass away before or after taking RMDs?
Designated Beneficiaries are further divided between eligible and non-eligible designated beneficiaries
Decedent Passes away before starting RMDs
Are you an Eligible Designated Beneficiary?
Beneficiaries may stretch the retirement distributions over their life expectancy or elect the 10-year rule. This specifically means that beneficiaries may continue to have a balance in the retirement account beyond the 10-year period. For minor children, they use life expectancy distributions until they reach the age of majority (usually 18 or 21, depending on state law). Once they reach the age of majority, the ten-year time frame begins, and the remaining account balance must be distributed within 10 years.
Spouses are provided with additional benefits not available to other beneficiaries. They can elect to treat the inherited IRA as their own, which allows them to defer RMDs until they reach their own required beginning date (age 73 or 75, depending on their birth year, as per the SECURE 2.0 Act). Alternatively, the surviving spouse can remain as a beneficiary and opt to take distributions based on their life expectancy, which requires annual RMDs but offers a longer payout period. They also have the option to delay distributions until the year the decedent would have reached the applicable age for RMDs, allowing for additional deferral. Spousal options can be confusing, and the decision may require the help of an advisor.
Are you a Non-Eligible Designated Beneficiary?
Only the 10-year rule applies in this scenario, meaning the beneficiary has the right to distribute all the assets in the 10th year, without having to take any distributions during years 1 through 9. For example, if an adult child is the beneficiary of the decedent’s IRA, they will not have to take a distribution until the 10th year, at which point the entire IRA balance must be liquidated.
Decedent Passes away on or after starting RMDs
Are you an Eligible Designated Beneficiary?
Distributions will be required each year because the decedent passed away after already starting RMDs. A beneficiary can take distributions based on their own life expectancy or based on the decedent, whichever is longer. This allows for annual distributions that stretch the payout over a longer period, offering tax deferral benefits without the requirement to liquidate the account by the 10th year. Minor children can use life expectancy distributions until they reach the age of majority, after which the 10-year rule applies, requiring the remaining balance to be distributed within 10 years.
Surviving spouses have the option to treat the inherited IRA as their own, allowing them to defer RMDs until they reach their own required beginning date, effectively resetting the account’s RMD schedule based on their age. Alternatively, a spouse may remain as a beneficiary and continue taking RMDs based on their own life expectancy, which can provide continued tax deferral and financial flexibility.
Are you a Non-Eligible Designated Beneficiary?
These beneficiaries, which normally consist of adult children, the entire balance of the inherited retirement account must be distributed by the end of the 10th year following the year of the decedent’s death. Additionally, this group must also take a required annual distribution based on the same distribution rate as the original decedent. This could mean that the retirement account could be distributed prior to the end of the 10th year. It is this category that has caused a great deal of confusion around distributions. For example, an adult child who inherits an IRA in many cases may have not taken any distributions and may have assumed they did not need to until the 10th year. The IRS has now clarified this and understands it has caused a great deal of confusion. Therefore, while the IRA must still be distributed by the 10th year following the decedents passing, there appears to be no penalties for those who did not take the required distribution, however, starting in 2025, beneficiaries in this category must be sure to take the annual distributions going forward.
Distributions for Non-Designated Beneficiaries: Estates, Charities, and Certain Trusts
Beneficiaries in this category, such as estates, charities, or certain types of trusts, do not have the same flexible distribution options as designated beneficiaries. If the decedent passes away before starting RMDs, the entire balance of the inherited IRA must be distributed by the end of the fifth year following the decedent’s death. There are no annual distribution requirements. If the decedent passes away after starting RMDs, the non-designated beneficiary must continue to take annual distributions based on the decedent’s life expectancy, using the IRS Single Life Expectancy Table. Distributions must be at least as rapid as the decedent’s schedule.
Understanding Complex Rules for Successor Beneficiaries and Trusts
The rules for primary beneficiaries are complicated, but it becomes even more complicated for successor beneficiaries (which are the beneficiary of a beneficiary). It is important to consult with your tax advisor if you are a successor beneficiary as the distribution rules vary based on several factors that are beyond the scope of this article.
Retirement account holders will also be best served to discuss distribution options with their attorney to analyze the impact of these rules on retirement accounts which have an estate or trust named as a beneficiary. Trusts can be a valuable estate planning tool for managing inherited IRAs, but they require careful planning and adherence to IRS rules to optimize their benefits.
Next Steps
As you navigate these complex changes to the RMD rules and consider their impact on your retirement and estate planning strategies, it’s essential to have expert guidance tailored to your unique circumstances. At Fairvoy Private Wealth, our team of qualified advisors is dedicated to helping you make informed decisions that align with your financial goals. Whether you have questions about your current plan or need to develop a strategy for managing inherited retirement accounts, we’re here to provide the expertise and support you need. Contact us today at 205-578-6250 or visit our website at https://fairvoypw.com to schedule a consultation and take proactive steps toward securing your financial future.
Important Disclosures
Fairvoy Private Wealth is registered as an investment advisor with the Securities and Exchange Commission (SEC). Any 3rd party information contained herein was prepared by sources deemed to be reliable but is not guaranteed. This information should not be used as the primary basis for investment decisions, nor is it advice meeting the specific investment needs of any investor.
Fairvoy Private Wealth do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
Please refer to the primary source for this paper for official information:
https://www.federalregister.gov/documents/2024/07/19/2024-14542/required-minimum-distributions
https://www.federalregister.gov/documents/2024/07/19/2024-14543/required-minimum-distributions