David T. Mayes
Over the past few years, we have seen many changes made to the required minimum distribution (RMD) rules that apply to traditional IRA and 401(k) accounts. The age at which these distributions must begin for account owners has been pushed out to age 73, new life-expectancy tables have been implemented to acknowledge that retirees are living longer, and, in perhaps the most impactful change for the US Treasury, the fact that non-spouse beneficiaries can no longer stretch withdrawals from retirement accounts over their own life expectancy. Instead, these inherited accounts must be emptied within 10 years of the owner’s death. This change, made under the SECURE Act of 2019 was dubbed the death of the “stretch IRA” and was designed to accelerate the receipt of tax revenue from IRAs after they are passed on to children.
The new 10-year rule applied to IRA and 401(k) accounts inherited by non-spouse beneficiaries due to death’s occurring after 2019. Note that spouses were not impacted since they already have the option to treat inherited accounts as their own and take distributions over their own life expectancy. The original reading of the SECURE Act left most IRA beneficiaries, account custodians and financial planners with the impression that a non-spouse beneficiary could leave an inherited IRA intact until just before the 10th anniversary of the owner’s death, taking no withdrawals until the final year, then pulling out the entire account balance. This might not be good tax planning, but it appeared to be an option for all non-spouse beneficiaries.
Subsequent guidance issued by the IRS, however, made it clear that the IRS interpreted the Act differently. For beneficiaries who inherited accounts after the original owner had reached the age at which their RMDs had begun, withdrawals from the inherited IRA needed to continue annually based on the life expectancy of the beneficiary. This basically allowed for a mini-stretch IRA, but still required the account to be emptied by the 10th anniversary of the owner’s death.
Given that this interpretation was released after the deadline for taking the RMD had passed for the beneficiaries impacted, the IRS also granted penalty relief that waived the RMDs from inherited accounts for 2020 and 2021. The new guidance released on July 14, 2023 in IRA Notice 2023-54 extends this penalty relief for 2023. So non-spouse beneficiaries of retirement accounts inherited in 2020 or later can continue to defer RMDs, whether the original account owner had started taking them or not, and plan to withdraw the entire account balance by the end of the 10th year. However, expect to see some final guidance issues by the IRS for 2024 that may require annual withdrawals for certain beneficiaries.
The best approach for handing withdrawals from these accounts may not be to delay them for as long as possible. It makes sense to consider your future income situation and available tax deductions with an eye toward taking larger inherited IRA withdrawals when other income might be lower of larger itemized deductions might be available. For instance, if you are planning to retire in two years, look to take larger withdrawals from the inherited account during that tax year and perhaps delay starting other income streams like Social Security. A year with unexpectedly large medical expenses would also be a reason to withdraw a larger amount from an inherited retirement account. Also look for years in which a large tax credit may be available such as the Residential Clean Energy Credit.
Another provision in the IRS’ new guidance extends the 60-day rollover deadline for retirement account owners who turned 72 in 2023 and already took an RMD. The SECURE Act 2.0 pushed the required beginning date for retirement account owners to age 73 but since the law was passed late in 2022, some IRA and 401(k) owners might have previously scheduled RMDs to occur earlier in the year. If so, these withdrawals can be returned to the original IRA or another IRA by September 30th as a rollover contribution to avoid the tax hit for 2023.
Note that the rules for spouses and certain other eligible beneficiaries who can still take life-expectancy withdrawals under the SECURE Act are not impacted by this new guidance. Non-spouse beneficiaries who inherited IRAs before 2020 are also still eligible to stretch distributions over their lifetimes.
David T. Mayes is a CERTIFIED FINANCIAL PLANNERTM professional and IRS Enrolled Three Bearings Fiduciary Advisors, Inc., a fee-only advisory firm in Hampton. He can be reached at (603) 926-1775 email@example.com.