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Like all IRA owners who have reached a certain age, beneficiaries of an inherited IRA (individual retirement account) are required to take RMDs (required minimum distributions) from the account they have inherited. However, over the past several years, how those distributions must be taken has evolved, leading to confusion and sometimes to penalties for failure to comply with the changing rules. The good news is, RMD relief has arrived—at least for the moment.
Why RMD Relief is Needed: a Brief History
Before discussing RMD relief updates, it’s helpful to understand how we got to a place of needing that relief in the first place.
Prior to the enactment of the SECURE Act at the end of 2019, beneficiaries who inherited an IRA could “stretch” distributions. They could calculate their life expectancy based on their current age in the IRS’ uniform lifetime table. The longer their life expectancy, the more years RMDs could be stretched over, and the lower the annual amount of the RMD. If you inherited an IRA before January 1, 2020, you can still stretch distributions in this way.
When the SECURE Act took effect in January 2020, it created classes of beneficiaries for traditional IRAs inherited after that date. “Non-eligible designated beneficiaries” were required to empty the inherited account by the end of the 10th year following the death. The rules for spouse beneficiaries were largely unchanged from before the SECURE Act took effect; they could elect to “roll over” the inherited funds into their own IRA or they could transfer the funds into an inherited IRA and take distributions based on their life expectancy. Other “eligible designated beneficiaries,” including chronically ill individuals, disabled individuals, and beneficiaries less than 10 years younger than the original account owner, also were not subject to the new 10-year rule.
While non-eligible designated beneficiaries were required to empty the IRA within 10 years, the assumption was that there were no annual RMDs required; the beneficiaries could wait until almost the end of the 10-year period and withdraw all the funds. But in February 2022, the IRS issued a proposed guidance that would have required not only complete withdrawal within 10 years, but an RMD in addition (based on the beneficiary’s single life expectancy). In other words, non-eligible designated beneficiaries would have to take a distribution annually and could not wait until the end of the 10-year window to empty the account of funds.
This proposed guidance came as a surprise to many financial professionals, who had not advised their clients that they had to take RMDs from their inherited IRAs. As a result, many beneficiaries suddenly found themselves potentially at risk of having to pay penalties for failing to withdraw funds in 2021 and 2022.
The proposed February 2022 guidance is still pending. In October 2022, the IRS waived penalties based on the proposed guidance for beneficiaries who failed to take RMDs in 2021 and 2022. In Notice 2022-53, the IRS also stated that final regulations on the matter will be forthcoming; those regulations would apply to the 2023 distribution year at the earliest.
Most recently, in July 2023, the IRS extended the penalty waiver to 2023 for affected beneficiaries. Beginning in 2023, the penalty for a missed RMD is reduced to 25% from 50%—still significant, but not quite as steep.
What RMD Relief in 2023 Means for You
The extension of the penalty waiver gives beneficiaries a little time and breathing room to plan for how distributions could affect their financial situation. Distributions from a traditional IRA, 401(k), 403(b), or other qualified plans are taxable income to beneficiaries of a plan. Depending on the amount of a distribution, beneficiaries could end up paying more in income taxes unless they plan ahead.
For instance, beneficiaries whose income is variable, or who expect a reduction in income, might take larger distributions during years when they are in a lower tax bracket—so long as doing so does not force them into a higher tax bracket. Another possibility is converting an inherited plan to a Roth IRA where possible. Charitable-minded beneficiaries might consider making qualified charitable distributions. For individuals who were contemplating a geographic move, moving to a state with a more favorable income tax might be a consideration. (Florida is not only popular with retirees because of its climate!)
In short, while the current RMD relief may not be permanent, it at least gives you time to consult with a financial advisor or tax planner to strategize for final IRA guidance on this issue.
One final note: if you have an IRA of your own, you probably know that the age at which you must begin taking required minimum distributions has been raised by the SECURE Act and SECURE 2.0. SECURE 2.0 raised the age to 73 for account owners who had not turned 72 by the end of 2022. What that means is that no IRA owners will reach an age in 2023 at which they must begin taking minimum distributions. In other words, you have more time to plan on that score, too.
To learn more about RMD relief and what to expect when the IRS issues its final guidance on RMDs for inherited IRAs, contact Estate Planning & Elder Law Services to schedule a consultation.
