No one likes losing flexibility, especially when it comes to finances. Thanks to some recent changes through the SECURE Act and new IRS guidance, inherited retirement accounts suddenly became a lot more rigid. If you inherited a retirement account in 2020 or later, you might be subject to required minimum distributions (RMDs) starting in 2021. Let’s look at the old inherited IRA rules were and how they’ve changed.
Old Stretch IRA Rules:
Prior to the passage of the SECURE Act in December 2020, retirement accounts (including IRAs, Roth IRAs, 401(k)s, 403(b)s, etc.) would transfer from the original owner’s account to a non-spouse beneficiary in the form of an inherited IRA. The beneficiary could not add more funds to this account and could not comingle these funds with other IRA dollars. The beneficiary of the inherited IRA then needed to take an annual RMDs based on the beneficiary’s expected lifespan. So, some younger beneficiaries had the benefit of being able to stretch these distributions out over 80 years or more.
Here’s the good news: if you inherited money from a non-spouse prior to 2020, then these old rules still apply! You can continue to stretch the distributions out over the rest of your lifetime by taking annual RMDs.
SECURE ACT Update:
The SECURE Act eliminated this stretch option and limited all new inherited IRAs to a 10-year rule. Initially, the financial community widely interpreted this rule to mean that no specific amounts needed to be withdrawn in any given year, but that the entire account balance needed to be withdrawn by the end of the 10th year after the year of inheritance. This interpretation still allowed a significant amount of flexibility within the 10-year window to manage tax exposure.
New IRS Guidance:
At the end of March 2021, the IRS released an update to its Publication 590-B which gives guidance for IRA distributions. This new publication specifies that the new 10-year window created by the SECURE Act will be less flexible than originally thought. This publication indicates that annual RMDs need to be taken throughout the 10-year window and requires that the account balance be distributed by the end of the 10th year. In reality, many beneficiaries will likely follow this pattern anyway in order to spread the tax exposure out over the 10-year period, but this dramatically reduces the flexibility of the 10-year window. Interestingly, this IRS publication is informational only and not official guidance, so we will have to wait until later this year for firm answers.
The old extra-long stretch rules ended thanks to the SECURE Act. Any non-spousal retirement accounts inherited in 2020 and beyond must follow the new 10-year window. However, it remains to be seen whether the 10-year window will provide complete discretion over the timing of distributions or whether it will include annual RMDs. If this situation applies to you, stay in touch with your financial advisor and tax advisor as the end of 2021 approaches.
Written by Jake Martin, Client Advisor