There has been some confusion in both the financial planning and tax worlds recently regarding the “new rules” around inherited IRA distributions. Congress was clear as mud when they decided to change all the rules in 2020.
You see before 2020, if you inherited an IRA, the rules were pretty straightforward, whether you were the spouse, child, sibling or any other named beneficiary of the IRA. Generally speaking , your annual required minimum distribution (RMD) was based on your life expectancy.
So, if a deceased 75 year old father bequeathed their IRA to their 50 year old son, the original RMD of the father was recalculated for the longer life expectancy of the son. The RMD was now much lower than what the father was required to take and pay income taxes on.
Which meant, Uncle Sam had to wait AGAIN to recoup the deferred taxes on this glorious tax advantaged account.
The SECURE ACT changed all this.
The “Setting Every Community Up for Retirement Enhancement” Act addressed the issue by eliminating what had been the “stretch provision”, where one’s RMD was calculated based on their life expectancy, as described in the example above.
I won’t get into all the nuances of the new rules here. Suffice it to say, there have been entire publications at this point regarding the changes, attempting to break down the confusion Congress presented two years ago and was forced to revisit and clarify in 2022.
Painting with a broad brush stroke, if you are a non-spouse and inherited an IRA in 2020 or later, you now have only 10 years to completely liquidate the account.
And the rules are different if the deceased was not yet required to take RMDs when they passed.
Most interpreted the original change to mean there were no longer RMDs, the account just needed to be empty in 10 years. Meaning, if it made sense for your situation, you could leave the assets invested for the next 9 years to continue growing tax deferred.
For the first two years of the SECURE ACT, many who were required to take distributions did not.
The IRS realized this blunder and put the brakes on it, telling everyone they had interpreted the changes incorrectly. RMDs were indeed still required, at least for some.
When you take it, whether or not you are required to take it and how much you have to take are the big questions you’ll need to answer, while also understanding the tax implications.
It is is a traditional IRA, as most that I see are, every dime you take out is 100% taxable as ordinary income, as if you earned that money from an employer.
To make things even more interesting and to keep us advisors on our toes, SECURE ACT 2.0 (that really is what it’s called) has just changed the age at which RMDs begin.
Honestly, SECURE ACT 2.0 made some sweeping changes that affect pretty much all of us. I plan to address many of them in my next newsletter, so stay tuned!
But for today I’ll leave you with this:
If you’ve inherited an IRA since 2020, you should check in with your financial or tax advisor to make sure you (and they) have a full understanding of your required distributions.