Making Sense of the Inherited IRA Rules

The requirement that one must take a certain amount of their pretax IRA as a taxable distribution on an annual basis over a specified age has always caused some confusion among IRA owners. This concept is known as the annual required minimum distribution (RMD) rules. The RMD rules prior to 2020 were considered confusing and frustrating. In December 2019, Congress passed the SECURE Act, which attempted to simplify how the RMD rules would work for a non-spouse. Unfortunately, things do not always go according to plan. The following will examine what RMD rules govern inherited non-spousal IRAs in 2023, as well as explore how the rules have changed from pre-2020 to now.

RMD Rules in a Nutshell

Designated beneficiaries of IRA and 401(k) accounts upon the death of the retirement account owner are subject to RMD rules. A beneficiary is defined as any person or entity the retirement account owner selects to receive the benefits of the plan after they die. Beneficiaries of an IRA, and most 401(k) plans, have the choice of selecting a lump-sum distribution of the inherited retirement account at any time. They must include any taxable distributions they receive in their gross income. The RMD rules apply to all IRAs, including Self-Directed IRAs.

In general, beginning in 2023, IRA owners must take his or her first required distribution by April 1 of the year after they reach age 73; that date is called their required beginning date (RBD). As a result of changes to federal law that took effect on January 1, 2023, the age at which you must begin taking RMDs differs depending on when you were born. If you reached age 72 on or before December 31, 2022, you were already required to take your RMD and must continue satisfying that requirement.  However, if you had not yet reached age 72 by December 31, 2022, you must take your first RMD by April 1 of the year after you reached age 73.

The Inherited IRA RMD Mess

The SECURE Act essentially shut down the “Stretch IRA,” which allowed a non-spouse IRA beneficiary to stretch out the IRA RMD payments over their life expectancy using a life expectancy table released by the IRS annually.

The Act essentially shortened the period for distributions from the balance of the beneficiary’s life to ten years. Except for surviving spouses and eligible designated beneficiaries, the new law forced beneficiaries of IRAs to withdraw all remaining funds within ten years of the original owner’s death, assuming they died after the required beginning date.  The SECURE Act included very few details of exactly how the ten-year rule would be applied and what type of flexibility the beneficiary would have in taking distributions over that period; it simply stated that all distributions must be taken within ten years while imposing no requirements on the rate at which they must be taken. As a result, many tax practitioners assumed that the IRA proceeds could be taken as a distribution at any time within the ten-year period, and even on the last day of the ten-year period.

IRS Inherited IRA Proposed Regulations

In February 2022, the IRS issued proposed regulations which ended up causing mass confusion in the retirement industry. The proposed regulations as drafted seem to require annual distributions from the inherited IRA, not just at the end of the ten-year period. The proposed regulations apparently required annual distributions to be taken based on the beneficiary’s age, likely using the single-life table.

As originally drafted, the IRS’s proposed regulation would have taken effect immediately, prompting anger and frustration from the retirement industry. The fear was the beneficiaries of inherited IRAs who elected to follow the ten-year rule outlined in the SECURE Act and did not take RMDs in 2021 or 2022 could be subject to excise tax penalties for two years based on the language in the February 2022 proposed regulations.

Considering these concerns and based on the fact that IRS Publication 590-B did not mention the RMD requirement until the 10th calendar year following the IRA owner’s death, the IRS agreed to pause the implementation of the February 2022 inherited IRA proposed regulations.

In an August 2022 announcement, the IRS stated that it would not apply the penalty to RMDs that should have been taken during 2021 and 2022 under the 2022 proposed regulations but were not.

The 2023 Inherited IRA Rules

Beneficiaries of IRAs inherited in 2020, 2021, or 2022 need to plan on taking RMD distributions in 2023. That RMD distribution should be at least as large as the RMD that would be indicated given their life expectancy and the age they attain on their 2023 birthday.  Below is a breakdown of how the RMD rules would work for a spouse or non-spouse IRA beneficiary in 2023.  Note – the IRS published Notice 2022-53, in which the agency clarified that it soon intends to publish a final regulation. 

Inherited IRA Rules From a Decedent who Passed Away After December 31, 2019

Non-Spouse Beneficiary

Under the SECURE Act, a designated beneficiary is required to liquidate the account by the end of the 10th year following the year of death of the IRA owner. However, the language in the February 2022 proposed regulations seems to have contradicted this in certain RMD instances. As a result, we are still waiting for final IRS regulations for the rules that will govern how the ten-year rule will work for a non-spouse who receives an IRA from a designated beneficiary.

There are exceptions to the ten-year rule for certain eligible designated beneficiaries, defined by the IRS, as someone who is either:

• The IRA owners’ spouse
• The IRA owner’s minor child
• An individual who is not more than 10 years younger than the IRA owner
• Disabled
• Chronically ill

However, once a minor child reaches the age of majority, they’ll become subject to the ten-year rule.

Generally, an eligible designated beneficiary may use the lifetime distribution rules that were in effect prior to 2020.

Spousal Beneficiary

Beginning in 2023, SECURE Act 2.0 raised the age that you must begin taking RMDs to age 73. If you reach age 72 in 2023, the required beginning date for your first RMD is April 1, 2025, for 2024. If the account holder’s death occurred prior to the required beginning date, the spousal beneficiary may:

• Keep as an inherited account.
  • Delay beginning distributions until the employee would have turned 72.
  • Take distributions based on their own life expectancy.
  • Follow the 10-year rule.
• Roll over the account into their own IRA, which is the most popular options especially if the surviving spouse is under the age of 73.

If the account holder’s death occurred after the required beginning date (age 73 in 2023), the spousal beneficiary may:

• Keep as an inherited account.
  • Take distributions based on their own life expectancy, or
• Rollover the account into their own IRA

Inherited IRA Rules from a Decedent who Died Before January 1, 2020

Non-Spouse Beneficiary

If the IRA account holder’s death occurred prior to the required beginning date, the non-spouse beneficiary’s options are:

• Take distributions based on their own life expectancy, beginning the end of the year following the year of death, or
• Follow the 5-year rule.

If the account holder’s death occurred after the required beginning date, the non-spouse beneficiary may:

• Take distributions based on the longer of their own life expectancy or the account owner’s remaining life expectancy.

Spousal Beneficiary

If the death of the IRA account holder occurred prior to the required beginning date, the spousal beneficiary’s options are:

• Keep as an inherited account in the name of the deceased spouse.
  • Take distributions based on their own life expectancy, or
  • Follow the 5-year rule.
• Rollover the account into their own IRA

If the death of the account holder occurred after the required beginning date, the spousal beneficiary’s options are:

• Take distributions based on their own life expectancy.
  • No 5-year rule available

IRS Notice 2022-53

In October 2022, the IRS published Notice 2022-53, in which the IRS clarified that it soon intends to publish a final regulation on the RMD rules inherited IRAs. The language in Notice 2022-53 suggests that the final IRS regulations will apply “no earlier than the 2023 distribution calendar year.”  The buzz is that the final regulations on inherited IRA RMD rules will be released towards the end of summer 2023.

Conclusion

It’s hard to imagine how it has taken almost three years to provide final rules on a set of rules that were not very complex to start with. When the SECURE Act was passed in 2019, the IRA industry was disappointed that the Stretch IRA option would end, but on the flip side, were happy with a simple ten-year rule for RMDs that was expected to be flexible. Instead, the February 2022 proposed regulations ended up muddling up the simple ten-year rule causing confusion for all retirement account holders. So now, in May 2023, we are back to where we were at the end of December 2019 waiting for the IRS to explain how the ten-year RMD rules will work. Stay tuned!