Prior to the 2019 SECURE Act (Setting Every Community Up for Retirement Enhancement), a non-spouse who inherited an IRA could take required minimum distributions based on the non–spouse’s life expectancy. In this manner, IRA owners who did not need retirement funds in excess of their required minimum distributions could provide an income stream for their children or other non-spouse beneficiary. The “stretch out” capability gave the money even more time to grow tax-deferred.
SECURE Act Eliminated The Stretch-Out, Imposed 10-Year Rule
The SECURE Act eliminated the stretchout IRA and replaced it with the ten year rule. Under the new rule, a non-spouse beneficiary who inherits an IRA after Jan. 1, 2020 must deplete the entire account within 10 years of the death of the original owner. IRS Publication 590-B (directions for preparing 2021 tax returns) states as follows:
The 10-year rule requires the IRA beneficiaries who are not taking life expectancy payments to withdraw the entire balance of the IRA by December 31 of the year containing the 10th anniversary of the owner’s death. For example, if the owner died in 2021, the beneficiary would have to fully distribute the IRA by December 31, 2031. The beneficiary is allowed, but not required, to take distributions prior to that date.
If the 10-year rule applies, the amount remaining in the IRA, if any, after December 31 of the year containing the 10th anniversary of the owner’s death is subject to the 50% excise tax detailed in Excess Accumulations (Insufficient Distributions), later.
At first blush, the rule seems straightforward: The entire account must be depleted by Dec. 31 of the year marking the 10th year following the original account holder’s death. It does not matter if the original participant dies before, after or on the original participant’s beginning date for RMD’s. What is not so straightforward is whether the non-spouse beneficiary is required to take distributions in years 1 through 9. Most analysts assumed it is not required, and that the only hard-and-fast rule is that the account must be emptied by year 10.
What To Do Until The 10-year Rule Is Clarified
On Feb. 23, 2022 the IRS published a new rule that many tax and financial analysts are calling a surprise curve ball: Under the rule, non-spouse beneficiaries must take distributions in years 1-9, and all funds must be depleted by year 10, IF the plan participant dies on or after the original participant’s beginning RMD date.
The new rule is still not set in stone, though. A period of public comment recently ended. Tax professionals are waiting to see if the IRS will further tweak the rule. Unfortunately, confusion over the rule has already caused some non-spouse beneficiaries to miss the deadline for RMD withdrawals. Whether the IRS will forgive any penalties is still unclear.
In this wait-and-see environment, a non-spouse who has inherited an IRA should speak with a tax professional to check on any updated rules. If you are the owner of an IRA thinking about leaving your IRA to a non-spouse, check with your estate planning attorney to examine other options that may be open to you. Call The Karp Law Firm for assistance at (561) 625-1100.