Normally a dry and straightforward topic, inherited IRA rules have been anything but over the last several years due to a number of recent changes to the SECURE Act of 2019. As a result of legislative changes (and the government’s need for tax revenue), there are now significant differences between non-spouse inherited IRA accounts inherited before and after January 1, 2020.
The Setting Every Community Up for Retirement Enhancement (or SECURE) Act of 2019 created a new 10-year rule that would require a non-spouse inheriting an IRA after 1/1/2020 to fully distribute the balance (all subject to ordinary income tax) within 10 years. Pre-2020 inherited IRA distributions will continue to be based on the life expectancy of the beneficiary.
To provide an example, if you inherited an IRA from a parent who passed away in 2020, as a non-spouse beneficiary, the deadline to take a full distribution is December 31, 2030. This seems pretty straightforward at first blush. However, what the IRS did not specify was when during the 10-year period distributions would be required to start, only the deadline for distributing the entire account. The early guidance allowed planners to customize the 10-year strategy for each participant, such as taking distributions in later years—when earned income isn’t contributing to a larger tax bill—for those on the cusp of retirement.
To further throw a wrench in these rules, the IRS proposed a rule in February 2022 to require owners to take equal periodic distributions during the 10 years. This update greatly complicated the ability for those in high tax brackets to exercise some control over the timing of these distributions. An update later in 2022 bought time for both the IRS to finalize the rules and for participants who had not yet taken distributions. If the original 2020 participant had not taken any distributions yet, they would not be penalized, although the original December 31, 2030 deadline would still apply.
As 2023 began, we expected the IRS would finalize its rules and require participants to take a distribution in 2023. However, this summer the IRS issued yet another update saying there will be no penalty for missed distributions for 2021, 2022, or 2023 (there was no required distribution in 2020 due to COVID). So, the “tax holiday” for non-spouse beneficiaries continues if they want to “let it ride” and enjoy more years of tax-deferred growth on those portfolios. That being said, it could make sense for some beneficiaries to begin withdrawals now, especially if they know a future liquidity event could contribute to a larger tax bill by waiting.
As we approach 2024, we are optimistic for finalized guidance from the IRS and will tailor our advice to clients accordingly. In the meantime, our strategy will be to continue providing updates to our clients as we receive them, and to craft a recommendation based on our knowledge of each client’s unique circumstances. If you have any questions about this topic, feel free to reach out to your Sand Hill Wealth Manager.
Source: www.irs.gov
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