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Understanding the Complex and Changing IRA Rules

In recent years, the landscape of tax rules and regulations for Individual Retirement Accounts (IRAs) has been evolving rapidly.1 It’s a challenging task to keep up with these changes to provide accurate and up-to-date advice to clients. One area that demands particular attention is inherited IRAs, which have some of the most complex distribution rules in the tax code.2 The consequences of misinterpretation can be severe. This post will address the common concerns people face regarding inherited IRAs and the key considerations to navigate this intricate territory.

When an IRA account holder passes away before taking their annual Required Minimum Distribution (RMD), the remaining amount must still be withdrawn, but by the beneficiary.3 The year-of-death RMD is not paid to the estate, except when the estate is the designated beneficiary. In such cases, it becomes taxable income for the beneficiary. If multiple beneficiaries exist, the IRS doesn’t specify who must take the year-of-death RMD; the important aspect is that it must be taken. Beneficiaries can choose to divide the year-of-death RMD equally among themselves or opt for a lump-sum payout. For instance, if a charity is a beneficiary; it might choose to take the full RMD in one lump sum.

It’s essential to note that the deadline for the year-of-death RMD is December 31 of the year of the original owner’s death.4 In situations where the account holder passed away late in the year, missing the RMD becomes common. To address this, the IRS created an extension for missed year-of-death RMDs. According to the proposed SECURE Act regulations, the penalty will be waived if the beneficiary withdraws the year-of-death Required Minimum Distribution (RMD) by their tax filing deadline, along with any extensions.

Since 2019, specific beneficiaries known as Eligible Designated Beneficiaries (EDBs) have retained the ability to stretch their Required Minimum Distributions (RMDs).5 This select group comprises surviving spouses, minor children of the account owner up to age 21, disabled or chronically ill individuals, and beneficiaries who are no more than 10 years younger than the IRA owner. When an EDB inherits an IRA, they use the IRS Single Life Expectancy Table to calculate the initial RMD factor in the year following the owner’s death. The factor is determined by the beneficiary’s age on their birthday in the year after the death. For subsequent years, a non-spouse EDB subtracts one from the previous year’s life expectancy factor, while a spouse EDB uses the applicable factor from the table for each subsequent year.6

According to the IRS proposed regulations, beneficiaries subject to the 10-year rule must take annual RMDs in years one to nine of the 10-year period if the IRA owner died on or after the Required Beginning Date (RBD).7 To calculate RMDs within the 10-year period, the beneficiary uses their own single life expectancy, not the account owner’s life expectancy, for the first RMD.8 The life expectancy is calculated based on the beneficiary’s age in the year of the initial RMD, which is the year following the account owner’s death. In each following year, the RMD factor decreases by one.

Given the ever-changing tax laws and IRS guidance surrounding IRAs, our financial advisors remain vigilant and well-informed on inherited IRA rules. By understanding and effectively navigating the complexities of inherited IRA distributions we can make informed decisions about retirement savings.9

Mark T. Nardella, MBA, CFP®
President, Financial Advisor

Securities and advisory services offered through Pinnacle Investments, LLC member FINRA/SIPC.