On July 18, 2024, the Internal Revenue Service (IRS) finalized rules regarding the withdrawal of funds from inherited retirement accounts. These new regulations state that most beneficiaries must withdraw a minimum amount each year over a 10-year period. This is a significant change from the previous policy, which allowed heirs to stretch withdrawals over their lifetimes, leading to smaller annual payouts and greater growth potential.
The Evolution of Withdrawal Rules
Before 2019, inheritors of individual retirement accounts (IRAs) or 401(k)s could spread withdrawals across their lifetimes. However, a law passed in 2019 mandated that many beneficiaries must withdraw all funds within 10 years. Initially, there was ambiguity regarding whether annual withdrawals were required or if beneficiaries could wait until the final year to withdraw all funds. Investors favored the latter option to maximize tax savings and allow their investments to grow.
Despite these preferences, the IRS’s final rules mandate annual withdrawals for most beneficiaries, aligning with what the agency believes Congress intended. These regulations affect most heirs, excluding spouses, and apply to future inheritors and those who inherited accounts since 2020.
Impact on Heirs and Planning for Retirement
Congress has been amending retirement account laws to increase revenue and prevent the wealthy from shielding money. These changes necessitate that individual investors continually adjust their retirement plans amidst evolving regulations. The new IRS rules exclude spouses who inherit an IRA, as different rules apply to them. Additionally, if the deceased account holder had not begun required minimum distributions (RMDs), heirs are allowed to withdraw funds any time within the 10-year period.
For heirs required to take annual payouts, the obligation begins the year after the original account holder’s death. This primarily affects children, grandchildren, siblings, and friends. Due to confusion about these new rules, many beneficiaries failed to take distributions in recent years. The IRS has waived penalties for missed withdrawals from 2021 through 2024, which typically carry a 25% penalty on the amount that should have been withdrawn. This penalty was reduced from 50% by a separate 2022 retirement law.
Heirs must begin taking annual withdrawals in 2025, with the amount calculated based on their life expectancy. This alleviates concerns about large payouts in 2025 due to skipped withdrawals from 2021 through 2024.
Special Considerations and Strategic Withdrawals
If the deceased account holder had not begun RMDs, heirs can choose to withdraw all funds at once within the 10-year period. Congress has been gradually increasing the age at which RMDs must start, with the current threshold being April 1 of the year following the account holder’s 73rd birthday. Withdrawals from traditional retirement accounts are taxable, so heirs should plan carefully to avoid substantial tax bills from balloon distributions in the final year.
The new rules add complexity to the already intricate landscape of IRA regulations. Beneficiaries may need to manage multiple IRAs with different payout rules. For those inheriting Roth IRAs, the news is more favorable: withdrawals are generally tax-free and can be delayed until the 10th year.
Certain beneficiaries, such as spouses and the chronically ill, will continue taking annual RMDs over their expected lifetimes. Heirs who inherited accounts before 2020 remain subject to the old rules, requiring annual withdrawals over their expected lifetimes.
Navigating these changes can be challenging, so consulting with a tax professional can help ensure compliance and optimize tax strategies under the new IRS guidance.
