The SECURE Act of 2019 made significant changes to the rules around IRAs left to individual beneficiaries or trusts. However, the IRS didn't release final regulations until 2024. To account for the uncertainty this created around certain required minimum distributions (RMDs), penalties around failure to take some RMDs were waived for tax years 2020-2024.
With final regulations in place, many non-spouse beneficiaries of an IRA now need to take RMDs, and distribute the balance of the account by the end of the 10th year following the year of the account owner's death, says David Peterson, head of wealth planning at Fidelity. "These new rules generally impact both IRAs that are left to non-spouse beneficiaries as well as IRAs left to a trust," Peterson says.
If you inherited an IRA, either directly or through a trust—or currently own an IRA that you might pass on—here is what the laws may mean for you and your heirs.
An IRA left to an individual
The original SECURE Act, also known as SECURE 1.0, included significant changes to the distribution rules for inherited IRAs.
Under the new rules, individuals named as beneficiaries are either considered Eligible Designated Beneficiaries (EDB), or Designated Beneficiaries (DB). An EDB includes spouses, children of the original account owner under the age of 21, someone not more than 10 years younger than the original IRA owner, or a disabled or chronically ill person; a DB includes any individual who is not an EBD (e.g., adult children, friends, and other family members like nieces, nephews, or grandchildren).
According to the SECURE Act rules, DBs of an IRA must fully distribute the balance by the end of the 10th year following the year of the account owner's death. This 10-year rule applies to both inherited traditional IRAs and inherited Roth IRAs. In addition, if the original owner of the IRA was already taking RMDs, their beneficiaries must continue withdrawals from their inherited IRAs. DBs are required to take RMDs in years 1 through 9 based on either their own life expectancy or the remaining life expectancy of the deceased account owner, whichever is longer. (Note: If the original account owner hadn't started RMDs yet then the DB can wait to the end of the 10-year period to complete a full distribution.) This is a change from the pre-SECURE rules, which generally allowed most beneficiaries to "stretch" RMD payments over their own life expectancy.
EDBs are not required to follow the 10-year rule and have more flexibility to stretch inherited assets over their life expectancy. Spouses and minor children also have some unique options: for example, spouses can transfer the money into an IRA in their name and take RMDs based on their own life expectancy, and minor children of the original account owner can take life expectancy distributions through age 21 and then the 10-year rule applies until age 31.
The penalty for not taking an RMD, or for taking less than the required amount, is 25% of the amount not taken on time (the 25% penalty can be reduced to 10% if the missed amount is removed within a certain period of time).
The final regulations offer some additional clarifications on these rules:
- Someone who inherited an IRA in 2020 through 2024 from an account owner who was taking RMDs does not need to make up for missed RMDs and will be not subject to penalties. However, they will have to start taking RMDs in 2025, and the 10-year rule will start with the original year they inherited the account. This means these beneficiaries will take RMDs for less than 9 years but will still be required to withdraw the full balance of their account by the end of their 10 years.
- Since there are no RMDs on a Roth IRA, the beneficiary can wait until the end of the 10th year to take a distribution from a Roth (at which point, the account must be fully distributed).
An IRA left to a trust
Investors who wish to pass their retirement accounts to beneficiaries through a trust may work with an estate planning attorney to structure the trust so that its beneficiaries qualify as the investor's designated beneficiaries. How the trust is structured will determine which beneficiaries are relevant in calculating RMDs.
Under the previous rules, when a trust was named as an IRA beneficiary, if the trust was properly drafted and the beneficiary designation was set-up to name a sub-trust for each beneficiary, the relevant beneficiary's life expectancy could be used to calculate RMDs for that sub-trust, stretching them over that individual's life expectancy.
Now, a trust can be structured so if the trust itself is named in a beneficiary designation. In this scenario, RMDs for each beneficiary's sub-trust can be calculated based on the specifics for the relevant beneficiary. However, as with designations to individual beneficiaries, the 10-year distribution rule often applies rather than a life expectancy payout.
"Given these changes, if you are leaving your IRA to an irrevocable trust and have not had your documents reviewed by an attorney since the end of 2019, it is critical that you do so to make sure distributions will be paid in accordance with your wishes," Peterson says.
In light of the act and final regulations, Peterson notes, many attorneys are now suggesting the use of customized beneficiary designations, which can specify multiple beneficiary types and monetary designations.
The bottom line
The new laws around inherited IRAs impacted many non-spouses who inherited IRAs post-2019, as well as those who may inherit them going forward. If you think your estate plan may include an IRA, make sure to work with an attorney who thoroughly understands the updated rules.