The IRS is providing relief to heirs of inherited IRAs who are subject to the 10-year rule, allowing them to skip required minimum distributions (RMDs) in 2023.
Up until a few years ago, if you inherited an IRA from a parent or grandparent, the withdrawal rules were clear: you could stretch distributions over your lifetime. Since then, however, the rules for non-spouse beneficiaries have been vague, fueling widespread confusion.
What Changed in January 2020: Secure Act 1.0
Let’s recap: The Secure Act of 2019 imposed stricter rules on non-spouse IRA beneficiaries by eliminating the “stretch” provision for heirs of people who passed away after 2019. As a result, those who inherit IRAs must take the full disbursement by the end of 10 years.
Within the new legislation, the IRS created three categories to define beneficiaries for traditional IRAs:
- Eligible designated beneficiaries (EDBs):
a. Surviving spouses
b. Children of the account owner until age 21
c. Disabled and chronically ill individuals
d. Individuals no more than 10 years younger than the original IRA owner
- Non-designated beneficiaries (NDBs):
a. Estates and certain trusts
- Noneligible designated beneficiaries (NEDBs):
a. Most non-spouse beneficiaries, such as children over age 21 and grandchildren
The NEDBs, or non-spouse beneficiaries, are the group impacted by and benefitting from the IRS RMD waivers.
Depending on the stage of life of the beneficiary, this could have significant tax implications, meaning much less of the inheritance would go to the intended recipient and rather go to the government.
Proposed Changes in 2022: RMD Rules
In early 2022, the IRS issued proposed changes to the new 10-year rule. In short, the proposal stated that if an IRA account owner passed away after s/he reached their “required beginning date” (generally by April 1 the year after their 73rd birthday), then the non-spouse beneficiary would be subject to taking withdrawals every year, with the entire balance distributed by the end of the 10th year after the owner’s passing. The thought is if the owner of the account is required to take the RMDs, so is the beneficiary.
However, if the IRA owner passed away before reaching h/er “required beginning date,” the non-spouse beneficiary would not be required to take RMDs. In this case, heirs would only be required to take the full distribution by the end of the 10th year after the owner’s passing, relieving them of any required annual withdrawals.
Penalty Waiver Notices Issued in October 2022 and July 2023
Because these proposed changes have not been enacted, the IRS issued two notices, Notice 2022-53 and Notice 2023-54, which offers temporary guidance while the changes are still in consideration. The notices simply state that heirs will not face a penalty if they opt out of taking RMDs in 2021, 2022, and 2023.
Of note, these notices do not extend the timeline for taking distributions, rather they only allow heirs to skip distribution in those years while the proposed regulations are being solidified.
Strategy to Extend the Life of the Inheritance
One potential strategy to circumvent these proposed changes is to split the primary beneficiaries to extend the life of the inheritance.
Take for example, a surviving spouse and a surviving child. Assuming the surviving spouse has satisfactory income to thrive in retirement, you may consider splitting the inheritance and naming both the surviving spouse and adult child as IRA recipients. The adult child would start taking distributions immediately on half of the inheritance, greatly reducing the tax burden. Upon the passing of the surviving spouse, the other half of the inheritance would start a new 10-year period of disbursements. This strategy has the ability to increase the distribution of funds over a longer period of time, thus reducing the overall tax bill.
As we wait for the final regulations, it’s important to take a look at your estate plan and consider how these changes may affect the tax burden of your loved ones. Contact an R&A advisor to discuss ways to create the smallest tax impact on them. We look forward to working with you to craft a tax-efficient plan.
About this Author
Dave specializes in tax research, estates and trusts, complex partnerships, and corporate, not-for-profit, and private foundation tax compliance.