Navigating The Inherited IRA Rules Post-SECURE Act

The Setting Every Community Up for Retirement Act of 2019 (SECURE Act) and SECURE 2.0 Act of 2022 (SECURE 2.0) made significant changes to the required minimum distribution (RMD) rules for inherited Individual Retirement accounts (IRAs). In the wake of these changes, there was lingering uncertainty amongst taxpayers regarding how and when these new rules will apply. Five years after the passage of the SECURE Act, the IRS has finally provided final regulations.   

The federal government has long recognized the need to incentivize American workers to save adequate funds for retirement. To this end, U.S. lawmakers have codified rules that allow taxpayers to defer federal income taxes on a portion of wages set aside for retirement. However, taxpayers are not allowed to defer taxes on their retirement savings indefinitely. The law requires taxpayers to begin taking distributions at a certain point. This is where the Required Minimum Distribution (RMD) rules come into play. The RMD rules generally mandate that taxpayers withdraw a certain minimum amount from retirement accounts once they reach a certain age. 

Internal Revenue Code Sec. 401 and RMD Rules 

Internal Revenue Code (IRC) Sec.  401(a)(9) requires a stock bonus, pension, or profit-sharing plan described in IRC Sec. 401(a) to make RMDs to the account holder (hereafter, taxpayer) starting by the required beginning date (RBD). This includes common retirement plans such as 401(k)s, 403(b)s, ESOPs, and IRAs, commonly referred to as defined contribution plans. The amount that must be distributed to the taxpayer is based on the age of the taxpayer, the amount in the retirement account, and their life expectancy. Failure to take your RMD can result in additional taxes and penalties. During life, the RMD rules are set forth in section 401(a)(9)(A) and after the death of the taxpayer in section 401(a)(9)(B).  

Inherited IRA RMD Rules Prior to the SECURE Act of 2019 

It is not uncommon for taxpayers to die before their retirement accounts have been fully distributed. Taxpayers may leave their retirement accounts to individual beneficiaries as an inheritance. Prior to the enactment of the SECURE Act, these inherited IRAs were then subject to the following RMD requirements, based on whether or not the taxpayer had begun taking RMDs or not: 

• If the taxpayer died after their RBD, then the beneficiary could take distributions based on the longer of: 
  
  • Their own life expectancy, or 
  • The deceased taxpayer’s remaining life expectancy.  
• If the taxpayer died before their RBD, their interest was required to be distributed either:  

1. 1. within five years after the death of the taxpayer (five-year rule), or  
   2. over the life or life expectancy of the designated beneficiary, with the distributions beginning no later than one year after the date of the taxpayer’s death. An exception under IRC Sec. 401(a)(9)(B)(iv) applied if the designated beneficiary was the taxpayer’s surviving spouse. 

SECURE Act of 2019 and the Ten-Year Rule 

The SECURE Act amended IRC Sec. 401(a)(9) by adding IRC Sec. 401(a)(9)(H), applicable for taxpayers who die after December 31, 2019. Under this amendment, if a taxpayer in a defined contribution plan has a designated beneficiary, the previous five-year rule is lengthened to ten years (ten-year rule).  The ten-year rule applies regardless of whether the taxpayer dies before or after their RBD.  

There is an exception to the ten-year rule if the beneficiary is an “eligible designated beneficiary.” Under Treas. Reg. Sec. 1.401(a)(9), eligible designated beneficiaries include designated beneficiaries who are: 

• The surviving spouse of the taxpayer, 
• A child of the taxpayer who has not reached the age of majority, as defined in the code, 
• Disabled, 
• Chronically ill, 
• Not more than ten years younger than the taxpayer, or 
• A designated beneficiary of a taxpayer who died on or after January 1, 2020. 

Under this exception, the ten-year rule is treated as satisfied if distributions are paid over the designated beneficiary’s lifetime or life expectancy. It is important to note that when an eligible designated beneficiary who is a minor child of the taxpayer reaches the age of majority, the child will no longer be considered an eligible designated beneficiary. At that point, the child’s portion of the taxpayer’s interest in the plan must be distributed within ten years of that date. 

Taxpayers have had varying interpretations of the ten-year rule and how it impacts the RMD rules. If a taxpayer died after their RBD and a designated beneficiary inherited the IRA, were annual RMDs required? Or would the full IRA simply need to be completely distributed by the tenth anniversary of the taxpayer’s death? In response to this uncertainty, the IRS issued proposed regulations in 2022. On July 19, 2024, the IRS released final regulations that generally follow those proposed regulations. 

Final Regulations  

The final regulations specifically address issues relating to the ten-year rule, particularly the question as to whether distributions must be taken on an annual basis in the case of a taxpayer who dies after their RBD. In general, the final regulations provide that the beneficiary, including eligible designated beneficiaries, must continue to take annual RMDs after the death of the taxpayer.  The IRA must be fully distributed by the tenth anniversary of the taxpayer’s death. The final regulations apply to calendar years beginning on or after January 1, 2025.  

Example 

To illustrate, assume Jane Smith is an IRA holder who passed away on July 1, 2023, at the age of 75. Her daughter, Sarah, is her designated beneficiary and is 40 years old.  

• IRA Holder: Jane Smith (age 75 at death) 
• Date of Death: July 1, 2023 
• Designated Beneficiary: Sarah (Jane’s daughter, age 40) 

Under the final regulations, Sarah must take an RMD in 2025 (the year in which the final regulations apply) and each subsequent year until the IRA is fully distributed in year ten. Sarah will calculate the RMD each year by dividing the IRA balance as of the end of the taxable year by her life expectancy factor (using the IRS Single Life Expectancy Table). The balance of the inherited IRA must be fully distributed by the end of the 10th year after Jane’s death, i.e., by December 31, 2033. If it is a pre-tax IRA, the RMD distributions will be taxed as ordinary income to Sarah. 

Inherited IRAs can cause headaches and complications. If you have questions about retirement plans, use the form below to connect with our team for guidance.