What’s up with the New 10 Year Rule?
Retirement Red Zone Edition #101025
The IRS’s interpretation of the 10-year clean-out rule on inherited IRAs was so complicated that it was finally resolved, almost five years after Congress took away a great benefit. No rush though!
They removed the ability for our beneficiaries to be able to stretch distribution IRAs over their lifetime. This speeds up how fast the IRS can get its hands on more tax dollars.
Sadly, many people living with the new rules have been kind of winging it for these tax years.
Getting the right tax advice and tips is vital in the ever-changing tax world we live in. What better place to get it than from accountant Joe
Some history
The “stretch IRA” is gone for most non-spouse beneficiaries who inherit IRAs. Before 2020, deceased owners of traditional IRAs could leave their accounts to their kids, grandkids, and the heirs could stretch required minimum distributions (RMDs) over their own lifetimes, thus allowing the funds in the accounts to grow tax-free for decades.
Congress removed the stretch IRA with 2019 SECURE Act legislation. Now there is a 10-year clean-out rule for many beneficiaries of inherited IRAs. The IRA funds must be distributed to them within 10 years of the owner’s death. This requirement applies to IRAs inherited after 2019.
For most non-spousal beneficiaries who inherit an IRA after 2019, the IRA funds must be distributed to that beneficiary within 10 years after death. So, if an IRA owner dies in October 2024, the beneficiary must clean out the IRA no later than December 31, 2034.
There are some exemptions for minor children or other beneficiaries who are disabled.
RMD are required for beneficiaries
How exactly does the 10-year cleanout rule work for IRAs inherited after 2019? Must the beneficiary take a distribution each year during those 10 years? Believe it or not, before July 2025, this question on distributions was a guessing game
The IRS’s original interpretation of the 10-year rule led many tax and retirement professionals to believe that the rule doesn’t mean that annual distributions to beneficiaries are required. It was instead thought that the beneficiaries:
Could wait until year 10 to take out all the money,
Take annual distributions
Skip years.
The IRS issued proposed regulations in 2022 further muddied the waters. Under the proposed regulations, the mechanics of the 10-year cleanout rule differed based on whether the original IRA owner died before or after his or her beginning date for taking RMDs. (Adding to the confusion, the old required beginning date was 70.5 it has now been increased to 73. And will increase to 75 in the future).
The IRS finally issued final regulations on whether an IRA owner dies before, or after, his or her RMD beginning date.
If the owner dies before his or her RMD beginning date,
Then beneficiaries needn’t take annual payouts. They can opt to wait until year 10 to take the money, get yearly distributions, or skip years, provided the IRA is fully depleted by the end of the 10-year period.
If the owner dies on or after the RMD start date,
Annual payouts are required. Beneficiaries must take yearly RMDs over the 10 years, beginning with the year after the original IRA owner died. This means RMDs must be paid to the beneficiary in years 1 through 9, with the rest of the account fully depleted by year 10. In this situation, the beneficiary figures annual RMDs based on his or her own life, so the younger the beneficiary, the smaller the yearly RMD amounts. Of course, the beneficiary can withdraw larger amounts from the IRA.
In this situation, the beneficiary would compute annual RMDs based on his or her life.
IRS’s Reprieve (how nice)
Beneficiaries of IRAs in which the original owner was already subject to RMDs won’t be penalized for not taking annual distributions in 2021-24. They needn’t make up for the missed distributions. In figuring the 2025 RMD, they start with the life expectancy factor that applied to the beginning of the 10 years and subtract one for each subsequent year.
Let’s take an example where a beneficiary inherits an IRA in 2021, the 10-year clean-out rule applies, the decedent started taking RMDs before death, and the beneficiary didn’t take RMDs in 2022, 2023, or 2024. Under the IRS’s final regulations, the beneficiary needn’t make up for the three years of missed RMDs. They must take only seven years of RMDs, starting with the first payout in 2025, and clean out the account by the end of 2031.
The 10-Year Rule for Roth IRAs
Similar to the rules for traditional IRAs, many non-spousal beneficiaries of Roth IRAs inherited after 2019 must clean out the account by the end of the 10th year after the owner’s death. But there are two key differences:
Similar to Roth IRA owners, Roth IRA beneficiaries are not taxed on distributions.
Because Roth IRA owners needn’t take RMDs when alive, beneficiaries of inherited Roth IRAs need not worry about whether the original account owner died before or after the starting date for taking RMDs.
As a result, beneficiaries of Roth IRAs:
Are not forced to take annual RMDs over 10 years.
They can clean out the account in year 1, or any time until the 10th year
Skip years,
or get annual distributions, provided they fully deplete the Roth IRA within the 10-year period.