What you need to know about RMDs starting in 2025.
The SECURE Act caused significant changes to the rules for inherited IRAs, impacting how beneficiaries receive these funds. One major change was the elimination of "stretch IRAs" for most non-spouse beneficiaries. This means that instead of stretching distributions over their lifetime, beneficiaries generally have to withdraw all the money within 10 years of the original account owner's death.
However, there was initial confusion about the specific rules for these 10-year distributions. Recent regulations have clarified these rules and provided clearer guidance for beneficiaries.
What Type of Beneficiary Are You?
First you have to determine which type of beneficiary you are because there are different rules depending on what category you fall into. Eligible Designated Beneficiaries (EDBs) have more flexibility and generally more time to withdraw money from an inherited IRA compared to Non-Eligible Designated Beneficiaries (NEDBs).
Eligible Designated Beneficiaries (EDB)
- EDBs are mainly the spouse, minor children of the deceased IRA owner, a beneficiary within 10 years of the owner’s age, chronically ill, and disabled beneficiaries.
- EDBs will not have to adhere to the 10-year withdrawal rule.
- They are the exception to the rules mentioned below but they still have to take RMDs based on how they handle their inherited IRA.
Non-Eligible Designated Beneficiaries (NEDBs)
- Anyone who doesn’t fit into the EDB category mentioned above.
- Have to adhere to the 10-year withdrawal rule.
- Have to adhere to the RMD rules explained below.
RMD Clarification for Non-EDB Beneficiaries
NEDBs have specific rules they must follow with inherited IRAs. For most non-spouse beneficiaries, the SECURE Act generally requires them to empty the inherited IRA within 10 years of the original owner's death. Initially, it was thought that beneficiaries only needed to withdraw the full amount by the end of the 10-year period, with no specific annual withdrawal requirements. However, proposed regulations in 2022 suggested a different approach and were finalized this year with specific guidelines.
The finalized rules now create a "hybrid system" if the original account owner died after they started taking RMDs. This means:
- 10-Year Rule Still Applies: The beneficiary must still empty the account by the end of the 10th year.
- Annual RMDs Also Apply: The beneficiary still has to take the money out by the 10th year, but they must continue taking RMDs for years 1-9 and still have all the money taken out by the 10th The beneficiary’s life expectancy is used to calculate their RMD payments. Essentially once the faucet of RMDs is turned on, it must keep pouring!
- In 2025, people who are in this situation must start taking RMDs. The IRS waived penalties until then so some beneficiaries chose to not take RMDs from IRAs inherited between 2021-2024 until the rules were finalized.
Example:
- A beneficiary inherited an IRA in 2021 from someone who was already taking RMDs.
- The beneficiary did not have to take RMDs until 2025 because the IRS waived penalties while they provided clarity on the rule.
- Now they will have to start RMD distributions in 2025, based on the beneficiaries’ life expectancy.
- The beneficiary STILL has to have the IRA emptied by 2031 because the 10-year period started the year of the death even though RMDs were waived for the first few years.
Other Considerations
- A beneficiary cannot convert an inherited IRA to a Roth IRA.
- Putting a trust as the IRA beneficiary doesn’t exempt you from these rules. Trusts often increase expenses but it does give you more control on when the trustees can access the funds. Something to keep in mind is the high rate of tax that trusts can incur. However, a Roth conversion can help prevent the high trust tax rates that the trusts will incur later. The account owner could take advantage of low tax rates now and convert to a Roth IRA to save their trustees in taxes down the road.
Talk with us about your situation.
The rules for inherited IRAs can be complex, and it's always best to consult with a qualified financial advisor or tax professional to understand your specific options and obligations as a beneficiary.