Planning Early For Inherited IRA Distributions Matters

There is no crystal ball for taxes or the future tax landscape, so waiting too long to begin your RMDs from an inherited IRA could result in adverse tax consequences. Coordinating the timing of your RMDs with tax factors such as anticipated income, deductions, and credits could help to minimize the negative impact on your inheritance....
David Roberts
December 28, 2022

Common Questions About Inherited IRA Distributions

If you inherited an IRA after passage of the SECURE Act in 2020, you may be one of the many Americans who are confused about the rules for required minimum distributions (RMDs). In the early part of 2022, the IRS did attempt to clarify how the distribution rules should be applied, but in the end they only added to the confusion. In this article I’d like to address some of the common questions surrounding this topic, as well as provide you with a resource which can help folks make wise financial decisions when they’ve experienced a sudden wealth event like an inheritance. Be sure to stick around to the end and get your copy of this FREE resource!

Are non-spouse beneficiaries allowed to spread distributions from an inherited IRA over their lifetime?

No. Since passage of the SECURE Act, non-spouse beneficiaries who inherit retirement accounts are now subject to the new “10-year rule.” This rule does not require RMDs yet does require all funds to be distributed from the account by the end of the 10th year following the death of the original IRA owner.

Before 2020 and the passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act, non-spouse beneficiaries were allowed to spread distributions from an inherited IRA over their lifetime. Those RMDs were calculated using a formula which included the beneficiary’s age and the balance of the account at the end of each tax year. This rule is commonly referred to as the “stretch” IRA rule and could last many decades for folks who received their inheritance at an early age. With the tax deferral of IRA accounts, this allowed for an excellent way to spread out the tax burden of the inheritance over many years. Currently, only certain eligible beneficiaries are allowed to continue using the stretch IRA rules.

Does the 10-year rule require any distributions before the end of the 10th year?

Unclear. The SECURE Act itself does not specify whether any distributions are required within the 10-year period. As such, most financial professionals believed that no withdrawals were required except for a complete liquidation of the account at the end of the 10th year following the death of the original IRA owner.

To provide some background, prior to the new 10-year rule, there was the “5-year” rule. Folks who inherit retirement accounts as beneficiaries of someone’s estate, and not as a listed beneficiary on a retirement account, fall under this rule. These individuals are required to empty the inherited account within a five-year time frame and without having to take RMDs. This is where the confusion began.

In February 2022, the IRS issued proposed regulations indicating that non-spouse beneficiaries of retirement accounts must take a required minimum distribution from the account annually if the original owner of the assets passed away following April 1 of the year after they turned 72. Financial professionals were then in a panic since that meant these RMDs should have first been taken in 2021, and their clients would now be subject to an additional 50% penalty, on top of the tax they owed on the distributions.

In October 2022, with all the confusion caused by this notice, the IRS issued further clarification in Notice 2022-53 saying that beneficiaries subject to the 10-year rule would be exempt from taking RMDs for tax years 2021 and 2022.

After 2022 will the IRS require RMDs for those subject to the 10-year rule?

Also, unclear. The October 2022 notice did not specify whether RMDs would be required beginning in tax year 2023. Tax professionals familiar with the actions of the IRS tell us that their silence might be interpreted in two ways:

  • They intend for Americans to follow their original interpretation requiring annual RMDs.
  • They intend to reverse course, eliminating all RMDs for non-spouse beneficiaries, except for a complete liquidation of the account by the end of the 10th year.

We’ll be looking for further guidance from the IRS in 2023.

Does it make sense to take voluntary distributions from an inherited IRA?

It depends. If you are a beneficiary subject to the 10-year rule, it would be prudent for you to consider the impact of various withdrawal strategies on your financial plan. Withdrawals spread out over the 10-year period can reduce the impact of additional taxes in any single year. Depending on your tax situation, this strategy may help you avoid being pushed into a higher tax bracket or being phased out of important tax credits and deductions.

Are inherited Roth IRAs treated the same way?

Yes. Inherited Roth IRAs are also subject to the new 10-year distribution rule. However, since Roth IRA distributions are tax-free to the beneficiary, we don’t see the tax-planning issues as with tax-deferred accounts such as an IRA, 401k, 403b, etc.

Final Thoughts About Inherited IRA Distributions

There is no crystal ball for taxes or the future tax landscape, so waiting too long to begin your RMDs from an inherited IRA could result in adverse tax consequences. Coordinating the timing of your RMDs with tax factors such as anticipated income, deductions, and credits could help to minimize the negative impact on your inheritance.

This is an area where a good financial planner can help. I would love to have the opportunity to discuss your inherited IRA and help you to understand how getting a hold on those RMDs is a great way to take control of your finances.

A Helpful Resource About Sudden Wealth Event

In addition to inheriting IRAs, folks may experience a variety of wealth events that lead to a financial windfall, including the sale of a business or real estate, lottery winnings, or a legal settlement. These are often critical times where receiving financial and tax guidance can make a positive impact.

My checklist, “What Issues Should I Consider If I Experience A Sudden Wealth Event?” will help guide you as you consider your options and the best course of action for your sudden wealth event. This checklist covers:

  • The nature, timing, and terms of the wealth event
  • Cash flow impact
  • Liquidity considerations
  • Tax planning matters

Click here to download this FREE resource.

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