Navigating Inherited IRAs Under SECURE 2.0: A Tax Perspective

The SECURE Act of 2019 brought significant changes to the landscape of retirement savings and inherited Individual Retirement Accounts (IRAs). Building on this foundation, SECURE 2.0, officially known as the Securing a Strong Retirement Act of 2022, further refines and expands upon the rules affecting inherited IRAs. With the continually evolving tax landscape it is important for beneficiaries to understand key considerations in optimizing tax strategies and effectively managing tax liabilities.

SECURE 2.0 introduced several new provisions and modifications to existing rules, impacting how inherited IRAs are managed and taxed. Understanding these changes is crucial for beneficiaries seeking to optimize their tax strategies.

Expansion of the Required Minimum Distribution (RMD) Age:

• What is an RMD? An RMD is the minimum amount that must be withdrawn annually from certain retirement accounts, such as Traditional IRAs, SEP (Simplified Employee Pension Plan) IRAs, SIMPLE (Savings Incentive Match Plan for Employees) IRAs, and employer-sponsored retirement plans like 401(k)s, starting at age 73 (as of 2024). The purpose of RMDs is to ensure that individuals withdraw funds from their retirement accounts and pay the applicable taxes. The amount of the RMD is calculated based on the account balance at the end of the previous year and a life expectancy factor provided by the IRS. Failure to take the RMD can result in substantial penalties.
• Increased RMD Age: SECURE 2.0 increased the RMD age from 73 to 75 over a phased period. For individuals turning 73 before January 1, 2033, the RMD age remains 73. Those turning 73 after this date will see their RMD age increased to 75.
• Impact on Inherited IRAs: This change affects beneficiaries who inherit IRAs from individuals subject to RMDs, potentially delaying when they must begin taking distributions.

Changes to the 10-Year Rule:

• What is the 10-Year Rule? The 10-year rule under the SECURE Act of 2019 pertains to the distribution requirements for beneficiaries of inherited retirement accounts. It mandates that non-spousal beneficiaries of these accounts must fully distribute the inherited assets within ten years following the death of the original account holder. This rule affects most beneficiaries, except for certain eligible designated beneficiaries. These exceptions include minor children of the account holder, disabled individuals, chronically ill persons, and beneficiaries who are not more than ten years younger than the deceased account holder. Unlike the previous rules, which allowed beneficiaries to stretch distributions over their lifetimes, the SECURE Act’s 10-year rule offers flexibility by not requiring annual distributions and allowing beneficiaries to withdraw funds at any time during the 10-year period.
• Clarification on the 10-Year Rule: The SECURE 2.0 Act provides additional clarification on the 10-year rule if the original account holder had already begun taking RMDs. Non-spousal beneficiaries must continue to take annual RMDs during the ten-year period. However, if the original account holder had not started RMDs, the beneficiaries can choose when to withdraw the funds, provided the entire account balance is distributed by the end of the tenth year.

Eligible Designated Beneficiaries (EDBs) and the Stretch Provision:

• Extended Stretch Options: SECURE 2.0 maintains the provision for eligible designated beneficiaries to stretch distributions over their life expectancy. EDBs include surviving spouses, minor children of the deceased IRA owner, disabled or chronically ill individuals, and beneficiaries not more than ten years younger than the original owner.
• Minor Children’s Transition: Once minor children reach the age of majority, they transition from the stretch provision to the 10-year rule, requiring the inherited IRA to be depleted within ten years of reaching adulthood.

Given the updated regulations under SECURE 2.0, beneficiaries of inherited IRAs need to adopt strategic approaches to manage their tax liabilities effectively. Key strategies to do so include:

Optimizing Distribution Timing:

• Staggered Withdrawals: To avoid a significant tax burden in the tenth year, beneficiaries should consider staggering withdrawals over the 10-year period. This can help to manage annual income levels and potentially keep beneficiaries in the lower tax brackets.
• RMD Compliance: For IRAs subject to annual RMDs during the 10-year period, beneficiaries must ensure they take the required distributions each year to avoid significant penalties.

Roth Conversions:

• Strategic Conversions: Beneficiaries inheriting traditional IRAs might benefit from converting the inherited IRA into a Roth IRA, particularly if they expect to be in a higher tax bracket in the future. While taxes are paid on the converted funds, future withdrawals and earnings after the 5-year holding period are tax-free, which can be advantageous.

Charitable Contributions:

• Qualified Charitable Distributions (QCDs): A QCD is a provision that allows individuals aged 70 ½ or older to directly transfer up to $100,000 per year from their IRA to a qualified charity. The distribution can count towards their RMD for the year but is excluded from their taxable income. The advantage of a QCD is that it allows the individual to satisfy their RMD requirements while reducing their taxable income. This strategy is beneficial for taxpayers who do not itemize their deductions. In order to qualify, the distribution must be made directly from the IRA trustee to the eligible charity.

The SECURE 2.0 Act brings important changes to the rules governing inherited IRAs, emphasizing the need for beneficiaries to stay informed and proactive in their tax planning. By understanding the new provisions and leveraging effective tax strategies, beneficiaries can navigate the complexities of inherited IRAs and optimize their financial outcomes.

Given the complexity of the rules under the SECURE Act of 2019 and the SECURE 2.0 Act, seeking advice from your Aldrich Wealth financial and Aldrich CPAs + Advisors tax professionals is key. We can work with you to provide tailored strategies to maximize the benefits of inherited IRAs while ensuring compliance with IRS regulations.