The IRS has quashed any remaining hope that it would alter its new guidelines for inherited individual retirement accounts, ending the “stretch” strategy for most beneficiaries. With its finding in rules issued last month that tax revenue-raising provisions of the 2019 Secure Act require so-called noneligible beneficiaries who have inherited IRAs in 2020 or later to transfer all the assets into their income within a decade, the IRS told financial advisors and their clients that there would be no more delays in implementation or a shift in the final statutes. This means beneficiaries must begin taking required minimum distributions (RMDs) next year — if they haven’t already started.
Experts agree that it’s likely past time to initiate that process. “Everyone thought there was a mistake. The longer we waited for the final regulations, the more the industry seemed to be thinking, ‘OK, they’re actually going to hold us to this,'” said Heather Zack, the director of high net worth solutions with Waltham, Massachusetts-based wealth management firm Commonwealth Financial Network.
The rules point to “a strategy that most advisors were taking already” in seeking to “equalize distributions over 10 years” rather than setting up a “tax bomb” by taking them all at once, she noted. “I don’t think there were many advisors who were telling their clients, ‘Let’s wait and take out everything in year 10.'”
The rules’ implications to retirement planning with “a tax component” merit a conversation with clients who inherited an IRA in any of the past four years, said Matthew Cleary, a financial planner with Wakefield, Massachusetts-based 401(k) and wealth firm Sentinel Group. “We want to bring that up absolutely, because it may be a situation where you do want to have more of a schedule to minimize the tax burden of taking it out in one year,” Cleary said.
“There are a couple of exceptions to that rule, but for the most part the stretch IRA is dead.”
Caveats to the new 10-year requirement apply to eligible designated beneficiaries — a group that includes the spouse of the deceased IRA owner, heirs who are chronically ill or disabled, and heirs younger than the late retirement saver by only a decade or less, Zack and Cleary noted. Another carve-out from the mandatory distributions applies to heirs who are 20 years old or younger, who can still use the stretch strategy until they are 21, according to a blog post by Sarah Brenner, director of retirement planning for IRA advice firm Ed Slott & Company.
Clarifying inherited IRA distribution rules
At that age, the new rules state that the beneficiary must launch their distributions and empty the accounts into their own income within the 10-year window. In addition, the rules maintained the “controversial” provision that most beneficiaries are subject to the 10-year guideline — even if the account owner died on or after the beginning period for the holder’s own required minimum distributions, Brenner wrote in another blog. “This rule requires annual RMDs to continue once they have started,” she wrote.
The IRS waived RMDs during the 10-year period for beneficiaries for the years 2021, 2022, 2023, and 2024. In the newly released final regulations, the IRS is doubling down on annual RMDs starting in 2025, but will not impose penalties for annual RMDs that were missed before 2025. IRA owners seeking to avoid a tax hit on their beneficiaries could convert traditional accounts to Roth ones, which usually won’t carry any more duties tied to the added income, Cleary noted.
“They would still be subject to the 10-year rule, but then they don’t necessarily have the tax issue,” he said. “It’s an idea for the right person who’s able to pay those taxes up front.”
Since inherited IRAs are “something that every advisor deals with,” the rules have created “this whole maze of different beneficiary withdrawal requirements” based on the year of the account owner’s death and the age, spousal and health status of the heir, she noted. And the final rule clarified that the 10-year distribution span started with IRA owners who died in 2020 — regardless of the fact that the IRS pushed back the required distribution four years in a row.
“It’s just made the landscape a lot more complicated for advisors and clients now than it used to be,” Zack said. “That is definitely of concern for some folks. That clock has been running this entire time.”
