Historically, distributions from inherited IRAs could be extended over the beneficiary’s lifetime, allowing the account to grow substantially, especially for younger beneficiaries. This approach facilitated significant long-term growth of the inherited IRA, given the smaller required minimum distributions (RMDs) that could be spread over many years.
Changes Introduced by the SECURE Act
The SECURE Act, enacted in December 2019, introduced substantial changes to the handling of inherited IRAs. With few exceptions, the Act mandates that the assets in an inherited IRA must now be distributed to the beneficiary within ten years. This shift represents a significant departure from the previous rules, requiring careful consideration of new distribution strategies.
Strategic Considerations for Distributions
Estate planners have debated the optimal strategy for these distributions under the new rules. Two primary approaches have emerged:
- Deferred Distribution: This strategy, which involves deferring distributions until the tenth year, offers a silver lining. It maximizes the period of tax-deferred growth, benefiting from compounding over the ten years and potentially resulting in a larger final distribution.
- Annual Distribution: Alternatively, distributing 10% of the assets annually over ten years can prevent pushing the beneficiary into a higher tax bracket, avoiding a significant tax hit in the final year.
Each strategy has its merits, and the best choice depends on the beneficiary’s individual tax situation and financial goals.
IRS Proposed Regulations and Unexpected Requirements
In its proposed regulations to implement the SECURE Act, the IRS highlighted an often-overlooked requirement: the beneficiary must continue distributions at the same rate if the original account owner had begun taking RMDs. Failure to comply with this requirement results in substantial excise taxes.
This proposal surprised many, as it introduced an additional layer of complexity to managing inherited IRAs.
IRS Response and Waiver of Penalties
Recognizing the confusion and surprise caused by the proposed regulations, the IRS responded by waiving penalties for missed RMDs from certain inherited IRAs for 2021, 2022, and 2023. This relief, provided through IRS Notice 2024-35, extends the penalty waiver for 2024. The Notice also indicates that the Regulation is expected to take effect in 2025, giving beneficiaries and planners additional time to adjust their strategies.
Looking Ahead
As the implementation of these new rules approaches, beneficiaries and estate planners must stay informed and adapt their strategies accordingly. The evolving landscape of inherited IRA distributions underscores the importance of professional guidance in navigating these complex regulatory changes. Beneficiaries should consult with their financial advisors to develop a distribution plan that aligns with their long-term financial goals and minimizes tax liabilities.
If you are a Legacy client and have questions, please do not hesitate to contact your Legacy advisor. If you are not a Legacy client and are interested in learning more about our approach to personalized wealth management, please contact us at 920.967.5020 or connect@lptrust.com.
This newsletter is provided for informational purposes only.
It is not intended as legal, accounting, or financial planning advice.
