Welcome to the 2024 version of Taxtember, a month focused on educating you on taxes. We will have articles about SECURE Act (sorry it is a little complex), the sunsetting of the TCJA, the difference between Standard and Itemized Deductions, and more. Enjoy the reading.
The SECURE Act was passed in December 2019 and it dramatically changed how Inherited IRAs were treated. However, the IRS did not spell out all of the rules as it left clients, advisors, custodians in limbo.
Prior to the SECURE Act, Inherited IRAs were relatively straightforward. If a spouse inherited an IRA, they could roll the balance into their own account and begin taking RMDs based on their life expectancy, starting at their Required Beginning Date (RBD). Non-spousal beneficiaries, such as children or other heirs, could also keep the Inherited IRA and take RMDs based on their life expectancy, allowing them to "stretch" the distributions over their lifetime. This was a beneficial strategy, as it enabled the assets to continue growing tax-deferred for many years.
The SECURE Act didn’t change the provisions for spousal beneficiaries, but non-spousal beneficiaries are now required to fully deplete the IRA within 10 years. The “stretch” is gone. Then the IRS also made known that they were considering required RMDS to continue during the 10-year window. Finally, back in July, the IRS clarified their position. According to these regulations, beginning January 1, 2025, most non-spousal beneficiaries must take RMDs from their Inherited IRA if the original account holder had already reached the age for RMDs. Importantly, these regulations are retroactively applied to accounts inherited from 2020 onward, when the SECURE Act first took effect.
It’s also important to note the changes in the Required Beginning Date (RBD) for RMDs. From 2020 to 2022, the RBD was age 72. In 2023, it increased to 73, and by 2033, it will rise to 75. This means that if someone passes away at 72 in 2024, their non-spousal beneficiary wouldn’t be required to take RMDs during the 10-year period. These shifting dates and rules can complicate planning, so it's essential to keep them in mind when managing an Inherited IRA.
The amount of RMDs is determined by the life expectancy of the beneficiary and the deceased. In most cases, the non-spousal beneficiary will be younger, meaning they’ll have a longer life expectancy. The RMD is calculated by dividing the prior year’s end-of-year balance by the IRS’s single life expectancy factor.
The best way to view this is an example. Let’s consider Lisa, who inherited an IRA from her father in 2024. If her father passed away at 75 and Lisa turns 50 in 2025, her RMD would be based on a life expectancy factor of 36.2. If the IRA balance at the end of 2024 was $500,000, her 2025 RMD would be approximately $13,813. In this scenario, the RMDs alone won’t deplete the account within 10 years (which would be 2035), so it’s critical to plan how to spread the tax liability over the decade.
Special Considerations for Roth IRAs
Interestingly, the IRS has specified that beneficiaries of Roth IRAs are not required to take RMDs during the 10-year period. The only stipulation is that the account must be fully depleted by the end of the 10th year.
If you’re an IRA or 401(k) owner planning to pass assets to a non-spouse beneficiary, now is an ideal time to review your estate plan. Consider the financial circumstances of your beneficiaries and the types of accounts you’ll be passing on. In some cases, it may make sense to leave IRA assets to lower-earning beneficiaries and Roth or brokerage accounts to higher earners to minimize their future tax burdens.
If you’re a non-spousal beneficiary of an IRA, it’s important to remember that these new rules apply only to IRAs inherited in 2020 and beyond. While the RMD requirement doesn’t begin until 2025, it’s vital to have a strategy in place for drawing down the account. Taking only the minimum required each year might result in a significant tax bill in the 10th year, so a well-thought-out plan can help mitigate this risk.
Conclusion
The SECURE Act has undoubtedly made the management of Inherited IRAs more complex. The IRS’s Final Regulations have provided some much-needed clarity, but they also underscore the importance of careful planning. Whether you’re planning your estate or managing an inheritance, it’s more crucial than ever to work closely with a financial advisor who understands these rules and can help you navigate the changes.
As always, we are here to help you make informed decisions that align with your financial goals. If you have any questions or need assistance in planning your next steps, please don’t hesitate to reach out. Together, we can ensure that your financial legacy is managed in the best possible way.