In December 2019 the SECURE Act was signed into law. This brought about changes to retirement savings and one of the most impactful changes applied to non-spousal beneficiaries of IRAs. The most common example of this is an adult child inheriting their parent’s IRA, so I will focus on this example. There are many other types of beneficiaries that can be named for IRAs, but children are the most common non-spousal beneficiaries.

Before the passage of the SECURE Act, a non-spousal beneficiary of an IRA had to take annual Required Minimum Distributions (RMDs) that were based on their own life expectancy. This meant that the younger the beneficiary was, the less they had to withdraw from the IRA every year, and the longer the account could continue to grow tax-free. Taking only the required minimum amount helped beneficiaries reduce their tax bill annually- especially if they did not need the money for living expenses. Passing IRAs down to children was a popular estate planning tool and set up younger generations to build wealth.

The SECURE Act changed this. If you inherit an IRA from someone who is not your spouse in 2020 or later, the funds in the IRA must be completely distributed within 10 years. When this law was changed there were a lot of unanswered questions. It was unclear if you had to take distributions every year and if there was a minimum you had to take. The IRS responded by further complicating inherited IRAs for beneficiaries. Now you must consider if the decedent died before or after their Require Beginning Date which is when IRA owners must begin taking RMDs.

For folks who inherited their parent’s IRA before their mom or dad began taking RMDs, all you must do is completely distribute the inherited IRA within 10 years. It does not matter how this is done according to the law, but there are of course better options than others when considering your own tax situation. If the decedent had begun taking RMDs, the beneficiary will need to take RMDs annually based on the beneficiary’s life expectancy and then empty whatever is left after 9 years of RMDs. A beneficiary may want to consider taking more than their RMD amount to smooth out the income (and taxes) over 10 years, but this strategy does not make sense in every situation.

Example:

Tom’s mom Tammy died in 2022 at the age of 65. Tom inherited her IRA which had $500,000 in it when she passed. Tammy had not reached her Required Beginning Date yet which means that Tom is not required to take anything from the IRA annually. He does have to completely drain the IRA by 2032 though.

Jane’s mom also died in 2022, but she was 80. Since Jane’s mom had begun to take her annual RMDs, Jane will also need to take an RMD every year for 10 years. Jane’s RMD amount is based on her own life expectancy, so it will be smaller than what her mom would have had to take. The kicker is whatever is left in the account in 2032 will have to be distributed. Again, this can cause some lumpy tax years if not planned for accordingly.

Since there was no clear indication if anyone was required to take distributions from these recently inherited IRAs some folks have not made any withdrawals from these accounts. In July the IRA released a notice stating that the RMDs from these accounts are waived for 2021-2023. This is good news for anyone who did not take their RMD in 2021 or 2022 and for anyone who would like to skip 2023 as well, we now know that is an option.

This new law has the potential to make a big impact on an IRA inheritor’s taxable income for 10 years and there are many different options and strategies that could be used. It is important to talk to a CPA or Financial Planner before making distribution decisions.