The IRS issued new guidance on April 16, 2024 in Notice 2024-35, providing relief for taxpayers facing the “10-year rule” for required minimum distributions (RMDs) from inherited IRAs or inherited defined contribution plans. This marks the third consecutive year the IRS has offered such relief.

However, Notice 2024-35 also indicates that final regulations concerning the rule are forthcoming and will be applied in determining RMDs for accounts in 2025 and beyond.

There are two main categories of people who inherit retirement accounts:

  • Eligible Designated Beneficiaries (EDBs): If you’re the spouse, minor child, an individual with disabilities, chronically ill person, or not more than 10 years younger than the original owner, you might still be able to stretch out those withdrawals over your lifetime.
  • Everyone Else: Most other people who inherit these accounts now fall under the “10-year rule.” This means you must take all the money out of the inherited account within 10 years of the original owner’s death.

SECURE Act Limits “Stretch IRAs”

The need for this latest guidance stems from the 2019 enactment of the Setting Every Community Up for Retirement Enhancement (SECURE) Act and the subsequent SECURE 2.0 Act of 2022. Among other changes, the legislations eliminated the strategy known as “stretch IRAs.”

Before the SECURE Act, all beneficiaries of inherited IRAs could stretch RMDs on the accounts over their entire life expectancies. This allowed younger heirs to take smaller distributions over decades, deferring taxes while the accounts grew. They also had the option to pass on the IRAs to future generations, further delaying tax payments.

To prevent this extended tax deferral, the SECURE Act imposed limitations on which heirs can stretch IRAs. Specifically, for IRA owners or defined contribution plan participants who died in 2020 or later, only “eligible designated beneficiaries” (EDBs) can stretch payments over their life expectancies.

The 10-Year Rule

All other heirs (“designated beneficiaries”) must empty the entire account within 10 years of the owner’s death, regardless of when the required beginning date (RBD) occurred. In 2023, the RMD start age increased from 72 to 73, pushing the RBD to April 1st of the following year.  RMDs will ultimately move to 75 in 2033.

Here is an example:

  • Your grandmother passed away in 2021 and left you her IRA.
  • You aren’t her spouse, a minor child, etc., so the 10-year rule applies to you.
  • Under the 10-year rule, you’d have to start taking required withdrawals right away and paying taxes on them.

Initial Response to Proposed Regulations

In February 2022, the IRS issued proposed regulations that caused significant confusion for many affected heirs. The regulations stipulated that, if the deceased died on or after the RBD, designated beneficiaries must take their taxable RMDs in years one through nine after death (based on life expectancies), with the remaining balance distributed in the tenth year. In other words, beneficiaries could not wait until the end of 10 years for a lump-sum distribution. This annual RMD requirement offered beneficiaries less tax planning flexibility and could potentially push them into higher tax brackets during those years.

The IRS quickly received feedback from bewildered taxpayers who had recently inherited IRAs or defined contribution plans and were unsure about when RMDs were required. This uncertainty created risk for both beneficiaries and the plans themselves. Beneficiaries faced potential excise taxes equal to 25% of undistributed amounts (reduced to 10% for prompt correction). The plans could be disqualified for failing to enforce RMDs.

A Series of Waivers

In response to these concerns, the IRS issued a waiver just six months after the proposed regulations were published. This waiver excused taxpayers subject to the 10-year rule from penalties for missed RMDs in 2021 and 2022, provided the plan participant died in 2020 on or after the RBD. The waiver also applied to missed 2022 RMDs if the participant died in 2021 on or after the RBD.

The initial waiver guidance indicated that the IRS would issue final regulations applicable no earlier than 2023. However, 2023 arrived, and the IRS extended the waiver relief once more, this time excusing missed RMDs in 2023 for participants who died in 2020, 2021, or 2022 on or after the RBD.

Notice 2024-35

The IRS has extended the relief from penalties again, applying this waiver to RMDs in 2024 from IRAs or defined contribution plans when the deceased passed away during the years 2020 through 2023 on or after the RBD.

Don’t Automatically Delay Inherited Retirement Account Withdrawals

While inheriting an IRA or retirement plan offers financial benefits, delaying withdrawals might not always be the best strategy. Here’s why:

  • Tax Rates Could Rise: Current tax breaks are set to expire beginning in 2026, potentially leading to higher tax rates on withdrawals. Taking some money out now could lock in these lower rates.
  • Avoid a Lump Sum Tax Bill: Even if the IRS allows a lump sum distribution in the 10th year, spreading withdrawals throughout the period can help avoid a large tax bill all at once.

However, delaying withdrawals may be wise for beneficiaries nearing retirement. They could be in a lower tax bracket when they stop working.

Recap of Important Things to Know

  • The 10-year rule can impact your taxes.
  • The IRS is still finalizing the rules. Things could change, so it’s important to check the IRS website for updates to the Notice 2024-35 and your tax advisor often for the latest updates on inherited retirement accounts.
  • Final rules are expected in 2025. That’s when we expect final regulations and rules on how the withdrawals will work.
  • Look to the professionals for help. Inherited retirement accounts are tricky. A tax advisor can help you understand your options and make the best choices for your situation.

The Bottom Line: Consider your individual circumstances and tax situation before deciding when to tap into inherited retirement accounts. Talk to a financial advisor to develop a personalized withdrawal strategy.

We’ll continue to monitor IRS guidance on Required Minimum Distributions (RMDs) and keep you updated on any changes.