Proposed Updates to Withdrawal Rules for Inherited IRAs

After passage of the SECURE Act, the rules became more complicated and less beneficial for many individuals who inherited IRAs. Now the IRS is proposing regulations to implement the SECURE Act, and this will likely make the rules surrounding inherited IRAs even more complex and less beneficial to owners of inherited IRA accounts. Before we discuss the new proposed rules, let’s review the SECURE Act.

The SECURE Act massively changed the rules surrounding how long owners of inherited retirement accounts had to withdraw the funds from the inherited account. Before the SECURE Act, inherited retirement accounts had required annual distributions based off the live expectancy of the beneficiary in most cases. If only the minimum required distribution schedule was followed, many inherited retirement accounts could last for decades. This is known as the “stretch” rules because it can stretch out the inherited retirement account for many years.

The SECURE Act instituted a rule that most owners of inherited retirement accounts must withdrawal all the funds from the account 10 years after the year of death of the original account owner.

Example: Ben is age 75 and passes away in 2021. His daughter, Mary, was the sole beneficiary. She fills out the paperwork and transfers the funds into her Inherited IRA account. Under the SECURE Act and before proposed IRS regulations, Mary would have until the end of 2031 to withdrawal all funds from the inherited IRA account. Mary would have flexibility from 2022 to 2030 in how much to distribute each year, whether she distribute everything early or nothing each year. In 2031, she will have to withdraw any remaining funds in the account by the end of the year.

However, the SECURE act created different categories of beneficiaries. 5 groups of beneficiaries continue to be eligible for the more beneficial stretch IRA rules.

  1. Spouses. Spouses can continue to rollover the retirement accounts of a deceased spouse into their own retirement accounts. They also retain the choice to participate in the required annual distributions based on their life expectancy.
  2. Disabled individuals. The rules are complex around who qualifies as disabled for this purpose.
  3. Chronically Ill Individuals. Again, the rules are complex around who qualifies under this. However, many individuals who require long-term care would likely qualify.
  4. Individuals who are close in age or older to the deceased account owner. If a beneficiary is within 10 years of age of the deceased account owner, they can continue the stretch rules. Additionally, anyone who is older than the deceased account owner can utilize the stretch rules. If a beneficiary is more than 10 years younger than the deceased account owner, they do not qualify based on their age (but can qualify if they met other criteria).
  5. Minor children of the descendent. Minor children of the descendent are eligible for the required annual distributions from the account only until they reach the age of majority. Once the child hits the age of majority and becomes an adult, they then have 10 years to fully withdrawal all the funds in the account. The new proposed regulations by the IRS sort out how to determine the age of majority.

The above group of beneficiaries who still have access to the more favorable stretch IRA rules are called eligible designated beneficiaries by the IRS. The individuals who don’t qualify for this but do qualify for the 10-year distribution rule are called non-eligible designated beneficiaries. Most beneficiaries who are living people who don’t qualify as an eligible designated beneficiary will qualify as a non-eligible designated beneficiary.

The new IRS proposed regulations complicate the topic and seemed to reverse previous guidance about how the SECURE Act would affect inherited IRA accounts. The proposed regulations if implemented, would accelerate taxes due from many inherited IRAs.

The SECURE Act said some beneficiaries would qualify for the rule that states all funds must be withdrawn from the inherited IRA within 10 years after the year of death of the original account owner.Let’s call them the 10-year rule beneficiaries. The IRS’s proposed guidance now splits the 10-year rule beneficiaries into two groups based on the age of death of the original account owner. If the original account owner passed away before their “required beginning date” then the rules stay the same for the 10-year beneficiary. However, if the original account owner passed away on or after their “required beginning date,” then the 10-year beneficiaries must follow the 10-year rule AND need to take required annual distributions each year after the year of death of the account owner. These distributions will be calculated according to the rules of the stretch. The required beginning date for most individuals going forward is April 1st of the year following the year in which the individual turned 72.

Use the chart below to see a summary of the confusing proposed withdrawal rules for inherited IRA accounts. Use the chart below to see which withdrawal rules you may qualify for based on the original account owner’s age and your beneficiary status.

Differing Withdrawal Rules

Eligible for 10 Year Rule

Not Eligible for 10 Year Rule

Original Account Owner did NOT attain their “required beginning age”

Inherited IRA account owner must follow:

1.    10 Year Withdrawal Rule

N/A – see other withdrawal rules

Original Account Owner DID attain their “required beginning age”

Inherited IRA account owner must follow:

1.    10 Year Withdrawal Rule

2.    Annual Required Distributions

N/A – see other withdrawal rules

There is a chance the IRS will reverse course to the more taxpayer-friendly route of no required annual distributions and only having to satisfy the 10-year withdrawal rule. Cross your fingers! Further guidance from the IRS should come before the end of the year.

Disclaimer: Please don’t consider this personalized advice for your situation. Always consult with your tax, legal, and investment advisors before taking any action.