If you inherited an individual retirement account from someone who died after 2019, a recent change in federal tax rules could affect the manner in which you make withdrawals known as required minimum distributions, or RMDs.
In 2020, the Internal Revenue Service began requiring most new inheritors who aren’t spouses or minor children of the deceased to empty the inherited retirement account over 10 years, rather than continuing to allow those inheritors to stretch out withdrawals over their own expected lifetimes. The IRS, however, didn’t indicate whether these inheritors had to make a minimum withdrawal each year, and many people were confused about whether they had to take annual amounts.
In May, however, the IRS made it clear in a rule revision that while the new 10-year rule stays in effect, there is no requirement to take an annual RMD during those 10 years. The inheritor can even withdraw the full amount in the first year, or wait until the 10th year, thus giving the assets more time, potentially, to grow. Here’s what the IRS said: “If the owner died in 2020, the beneficiary would have to fully distribute the plan by December 31, 2030. The beneficiary is allowed, but not required, to take distributions prior to that date.”
To know if the 10-year rule and the recent change apply to you, you have to know in which of two categories you fall according to the 2020 Secure Act (Setting Every Community Up for Retirement Enhancement). The act says that individuals who inherit an IRA are considered either eligible designated beneficiaries or designated beneficiaries. Each category has different requirements for withdrawing funds from the inherited IRA when turning 72 and starting to make RMDs. Note also that these rules apply not just to traditional and Roth IRAs but also to defined-contribution plans for employees, such as 401(k) plans, 403(b) plans and 457(b) plans. They don’t affect defined-benefit plans.
“It’s confusing,” warns Sarah Brenner, director of retirement education at Ed Slott & Co., a tax consulting firm in Rockville Centre, N.Y. But here’s what you need to know.