Towards the end of the year comes the excitement of Required Minimum Distributions (RMDs) – and for many that excitement is coupled with anxiety that comes from a resulting tax liability. Those that get to participate in this excitement and anxiety is a growing group with the passage of the SECURE Act of 2019 and the IRS (finally) publishing final regulations on July 18, 2024.
Since the passage of the SECURE Act, the “stretch” IRA is no longer permitted on inherited IRAs (if the original account holder passed after December 31, 2019). With this new protocol there was confusion surrounding the timing that a beneficiary had to act and withdraw the funds from the inherited IRA. Common questions without great answers were abound:
Do I have to withdraw the funds every year? Can I wait and withdraw all of it in last year? Can I withdraw it early? Can I skip a year, or two?
Now that the IRS has issued final rules regarding required withdrawals for certain inherited individual retirement accounts (IRAs) and other plans – we have clarity on how these distributions need to be timed and handled. However, we caution that beneficiaries may face higher taxes in the future if they only take the minimum withdrawals now – depending on their tax situation. As always, the answer is “it depends”.
According to the new regulations, most non-spouse beneficiaries must fully deplete inherited retirement accounts within 10 years of the original owner’s death. Additionally, these heirs are required to take annual required minimum distributions (RMDs), a matter that had been uncertain for years.
Prior to the Secure Act of 2019, beneficiaries could “stretch” withdrawals over their lifetimes, which minimized yearly tax liabilities. The new 10-year window, however, could result in larger tax bills during withdrawal years, especially for high-income heirs.
While the final regulations address the RMD amount and timing, there is no maximum and beneficiaries may want to consider withdrawing more from inherited accounts now while tax rates are lower as withdrawals from pre-tax inherited accounts are subject to regular income taxes. Currently, and for the past 6 years, we are and have been in a historically low tax rate environment.
Without legislative changes, many individual tax provisions, including lower federal income tax brackets, are set to expire after 2025, reverting to higher rates of 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%.
Of course, the possibility of higher taxes after 2025 remains uncertain, and other factors could influence the decision to withdraw funds sooner. It’s important to weigh current-year tax implications and future tax projections before increasing income through faster retirement account distributions.
After years of waived penalties, starting in 2025, certain heirs will need to begin annual RMDs from inherited accounts under the new and finalized IRS rules. If you have inherited an IRA from 2020 on it is important that you gain an understanding of what’s going on, what your obligations are, and how this fits into your overall tax picture and planning – keeping in mind that whenever we have the ability to plan surrounding tax efficiency, we should take a multi-year approach as every year you don’t use the lower brackets is a wasted opportunity.
Small print … but important …
The new guidelines apply to heirs who are not a spouse, minor child, disabled, chronically ill, or certain trusts. The annual withdrawal rule only applies if the original account owner had reached their RMD age before death. If you miss the annual RMDs or do not withdraw enough, there is a 25% penalty on the amount you should have withdrawn. This penalty can be reduced to 10% if the RMD is “timely corrected” within two years, according to the IRS.