The IRS has finally provided much-needed clarity on the rules surrounding inherited retirement accounts, a topic that Bequest law has followed closely since the 2019 SECURE Act. This new guidance is crucial for heirs trying to navigate the complex web of regulations governing withdrawals from these accounts.
A Shift in Withdrawal Rules
Before 2019, heirs had the flexibility to stretch out withdrawals from inherited retirement accounts, such as IRAs and 401(k)s, over their lifetimes. This allowed for smaller, more manageable payouts, minimized income taxes, and maximized the growth potential of the accounts. However, the 2019 SECURE Act legislation changed to rules to require most non-spouse heirs to withdraw the full amount of an inherited retirement account within 10 years, a significant shift that left many questions unanswered.
On July 18, 2024, the IRS finalized rules that clarify how heirs must approach these withdrawals. For most beneficiaries, the new rules require that they take a minimum withdrawal every year over the 10-year period. This contrasts with the previous assumption that heirs could wait until the final year to withdraw all the funds, potentially enjoying tax-deferred growth in the meantime.
Who it Effects
These new IRS rules primarily affect non-spousal heirs—children, grandchildren, siblings, and friends—who now need to adjust their financial strategies. If the original account holder was required to take minimum distributions (“RMDs”) before their death, the heir must start taking annual withdrawals the year after the account holder’s death.
For those who inherited accounts between 2020 and 2023, this guidance is especially crucial. The IRS has granted leniency by not penalizing heirs who failed to take required payouts from 2021 to 2024, but starting in 2025, these heirs must comply with the annual withdrawal requirements.
Avoiding a Tax Balloon
One of the significant concerns for heirs of an inherited IRA is the potential for a "tax balloon" in the final year if they follow the minimum withdrawal schedule each year. For instance, if an heir inherits a $100,000 IRA in 2020 and only takes out the minimum amount each year, they could face a substantial tax bill in the final year, 2030, due to a large remaining balance.
This could push the heir into a higher tax bracket, significantly increasing their tax burden. To mitigate this risk, heirs should consider withdrawing more than the minimum required each year, particularly if they expect their income to remain steady or increase in the future.
Best Accounts to Inherit: Roth IRAs
While the new rules apply broadly, one bright spot remains for heirs of Roth IRAs. Unlike traditional retirement accounts, Roth IRAs do not require annual withdrawals, allowing heirs to take advantage of tax-free growth until the 10th year when the entire account must be depleted.
Navigating Multiple IRAs and Complex Rules
The final rules do not entirely eliminate the confusion surrounding inherited IRAs. Heirs with multiple accounts may find themselves juggling different sets of rules, especially if they have inherited accounts under both the old and new laws. This complexity underscores the importance of careful planning and of seeking professional guidance.
The Importance of Estate Planning
These IRS rules highlight the need for comprehensive estate planning, particularly as Congress and the IRS continue to adjust and interpret laws governing retirement accounts. Heirs and those planning their estates should stay informed and consider how these changes might affect their financial strategies. The new guidance, while offering some clarity, also adds layers of complexity that necessitate careful consideration and expert advice.
For those managing inherited retirement accounts, the time to act is now—before the 2025 deadline looms large. Contact Bequest Law for specialized advice on how to structure your retirement account beneficiaries and to build a comprehensive estate plan. To schedule a free consultation with a Bequest attorney you can submit an inquiry form on the main page of our website (https://www.bequest.law), call at 404.500.7531, or email hello@bequest.law.