In the world of finance, the 10-year rule on inherited IRAs has become a significant point of discussion, particularly for those planning their estates or beneficiaries inheriting retirement accounts. An inherited IRA is a retirement account that a beneficiary receives after the original owner’s passing. Traditionally, beneficiaries had the option to stretch withdrawals from these accounts over their lifetime, but the Secure Act, passed in 2019, brought significant changes including introduction of the 10-year rule.

The 10-Year Rule

This rule mandates that non-eligible designated beneficiaries of inherited IRAs must withdraw the entire balance of the account within ten years of the original owner’s death. However, eligible designated beneficiaries are still allowed to stretch the IRA and take distributions based on their life expectancy.

The IRS defines an eligible designated beneficiary as someone who meets one of the following requirements:

  1. Spouse or minor child of the deceased account holder.
  2. Disabled or chronically ill individual.
  3. Individual who is not more than ten years younger than the IRA owner or plan participant.

RMD Rules

A main concern many beneficiaries have regarding inherited IRAs relates to the Required Minimum Distribution (RMD) rules. The IRS issued proposed regulations in 2022 which clarified that there are indeed two sets of rules beneficiaries must follow with IRAs inherited in 2020 or later. The rules are the 10-year rule and the annual RMD, meaning beneficiaries need to take distributions out each year in the 10-year window. IRAs inherited before 2020 can be stretched and distributed over the beneficiary’s life expectancy.

Due to confusion on the regulations, the IRS has granted penalty waivers each year for beneficiaries who did not take an RMD during 2020-2023. The IRS announced this past April that they are also waiving the penalty for 2024 RMDs. If someone has already taken their RMD in 2024, the distribution cannot be redeposited into the inherited IRA.

Even though there is not an RMD requirement in 2024, beneficiaries should consider taking a distribution out this year to spread out the income being reported on their tax return over multiple years. Waiting and taking a lump sum distribution in the last (tenth) year could be enough to jump into a higher tax bracket!

Reach out to your tax advisor at KT to discuss your best options to minimize tax on an inherited IRA distribution.