Many beneficiaries who inherited IRAs in 2020 or later have struggled with the changes to inherited IRA rules that were part of the SECURE Act of 2019. While the act passed in 2019, the IRS didn't release proposed regulations on the changes until 2022, and issued final regulations only a few months ago. In the meantime, penalties on any required minimum distributions (RMDs) for inherited IRAs were waived for tax years 2020 through 2024.
However, following clarifications in the final and proposed regulations, many non-spouse beneficiaries of an IRA will need to begin taking RMDs in 2025, and fully distribute the balance of the account by the end of the 10th year following the year of the account owner's death, says David Peterson, head of wealth planning at Fidelity. "These new rules generally impact both IRAs that are left to non-spouse beneficiaries as well as IRAs left to a trust," Peterson says.
If you inherited an IRA, either directly or through a trust—or currently own an IRA that you might pass on—here are the final clarifications on what the new laws may mean for you and your heirs.
An IRA left to an individual
The original SECURE Act, also known as SECURE 1.0, included significant changes to the distribution rules for inherited IRAs.
Under the new rules, individuals named as beneficiaries are either considered Eligible Designated Beneficiaries (EDB), or Designated Beneficiaries (DB). An EDB includes spouses, children of the original account owner under the age of 21, someone not more than 10 years younger than the original IRA owner, or a disabled or chronically ill person; a DB includes any individual who is not an EBD (e.g., adult children, friends, and other family members like nieces, nephews, or grandchildren).
According to the SECURE Act rules, DBs of an IRA must fully distribute the balance by the end of the 10th year following the year of the account owner's death. This 10-year rule applies to both inherited traditional IRAs and inherited Roth IRAs. In addition, if the original owner of the IRA was already taking RMDs, their beneficiaries must continue withdrawals from their inherited IRAs. DBs are required to take RMDs in years 1 through 9 based on either their own life expectancy or the remaining life expectancy of the deceased account owner, whichever is longer. (Note: If the original account owner hadn't started RMDs yet then the DB can wait to the end of the 10-year period to complete a full distribution.) This is a change from the pre-SECURE rules, which generally allowed most beneficiaries to "stretch" RMD payments over their own life expectancy.
EDBs are not required to follow the 10-year rule and have more flexibility to stretch inherited assets over their life expectancy. Spouses and minor children also have some unique options: for example, spouses can transfer the money into an IRA in their name and take RMDs based on their own life expectancy, and minor children of the original account owner can take life expectancy distributions through age 21 and then the 10-year rule applies until age 31.
The penalty for not taking an RMD, or for taking less than the required amount, is 25% of the amount not taken on time (the 25% penalty can be reduced to 10% if the missed amount is removed within a certain period of time).
The final regulations offer some additional clarifications on these rules:
- Someone who inherited an IRA in 2020 through 2024 from an account owner who was taking RMDs does not need to make up for missed RMDs and will be not subject to penalties. However, they will have to start taking RMDs in 2025, and the 10-year rule will start with the original year they inherited the account. This means these beneficiaries will take RMDs for less than 9 years but will still be required to withdraw the full balance of their account by the end of their 10 years.
- Since there are no RMDs on a Roth IRA, the beneficiary can wait until the end of the 10th year to take a distribution from a Roth (at which point, the account must be fully distributed).
An IRA left to a trust
Investors who wish to pass their retirement accounts to beneficiaries through a trust often set up what's known as a "see-through" trust, which allows IRA distributions either to pass directly to beneficiaries (a "conduit trust") or remain in the trust (an "accumulation trust"). The type of trust will determine which beneficiaries are included in calculating the RMD.
Under the previous rules, when a trust was named as an IRA beneficiary, if the trust was properly drafted and the beneficiary designation was set-up properly, each beneficiary's life expectancy could be used to stretch the payments over the individual trust beneficiary's life expectancy. If the trust wasn't structured to distribute the underlying assets to the trust beneficiaries or there was a delay in that distribution, the life expectancy of the oldest trust beneficiary would be used to stretch payments.
The final SECURE regulations modified this rule. Now, assuming the trust is a "see-through" trust and the terms require the trust to terminate an immediate distribution to either sub-trusts or to an inherited IRA for the trust beneficiaries, the RMD can be calculated based on specifics for each trust beneficiary.
In addition, the 10-year distribution rule applies to IRAs left to a trust, if a trust beneficiary is a designated beneficiary as mentioned above. In that case, distributions from the IRA left to the trust must be distributed over 10 years.
"Given these changes, if you are leaving your IRA to an irrevocable trust and have not had your documents reviewed by an attorney since the end of 2019, it is critical that you do so to make sure distributions will be paid in accordance with your wishes," Peterson says.
In light of the act and final regulations, Peterson notes, many attorneys are now suggesting the use of customized beneficiary designations, which can specify multiple beneficiary types and monetary designations.
Finally, if the beneficiary of your IRA is not an individual or a "see-through" trust—for example, a charity or the estate—it will be subject to a 5-year rule, meaning the IRA must be distributed within 5 years of the owner's death. This is consistent with the rules prior to the SECURE Act.
The bottom line
The new laws around inherited IRAs will impact many non-spouses who inherited IRAs post-2019, as well as those who may inherit them going forward. If you think your estate plan may include an IRA, make sure to work with an attorney who thoroughly understands the updated rules.