CONTRIBUTORS
Bill Cass, CFP®, CPWA®
Director of Wealth Planning,
Franklin Templeton
With proposed regulations now finalized, investors have clarity on the 10-year rule for inherited retirement accounts.
The IRS recently issued final regulations for the 10-year rule for the distribution of inherited retirement accounts. The long-awaited final regulations essentially retain the proposed rules.
In December 2019, the SECURE Act was signed into law, introducing a new 10-year distribution rule on most non-spouse inherited retirement accounts. The 10-year rule defines the time period for heirs to achieve complete distribution of inherited retirement assets.
The final regulations essentially state that there are two versions of the 10-year rule, depending on the age of the account owner at death.
- Death before required beginning date (RBD). This is the simple 10-year rule. The account must be fully distributed (at least) by the end of the 10th year following year of death of the owner. No annual distributions are required.
- Death after RBD. The account still has to be fully distributed by the end of the 10th year, but there must also be (at least) annual distributions which are calculated based on the account beneficiary's life expectancy.
The RBD is generally April 1 of the year following the calendar year in which the account owner reaches age 73. In the case an account owner passes away after the RBD, designated beneficiaries and eligible designated beneficiaries may also opt to base annual distributions on the remaining life expectancy of the deceased account owner.
Penalty waiver for 2024
- Even though the regulations are now final, the IRS issued guidance earlier this year stating there is no penalty for not taking an annual distribution in 2024. This follows similar relief issued by the IRS in 2021, 2022 and 2023.
- With the waiver, heirs did not receive “extra years.” Despite the ability to skip annual distributions while proposed regulations were still being considered, heirs were still subject to their original 10-year period.
Planning considerations
Since the 10-year rule may result in the distribution of retirement account balances sooner than anticipated, there may be unintended income tax issues for beneficiaries.
Here are some potential considerations:
- Account owners may want to leave other assets to higher-income heirs, leaving retirement funds to beneficiaries in lower, or moderate, income tax brackets.
- Account owners may consider spending down (or converting to a Roth) retirement funds while living, depending on their tax circumstances.
- For those over the age of 70½, qualified charitable distributions (QCDs) may be a tax-efficient method of drawing down IRA funds while satisfying charitable wishes.
- Retirement account heirs will want to time taxable distributions from inherited accounts over the 10-year period in conjunction with their personal tax situation.
- If possible, heirs of Roth IRAs may wish to wait until the last year of the 10-year period before distributing the account, allowing for potential tax-free growth over that period.
Seek advice
It’s important for those inheriting a retirement account to consult with a financial professional to determine a distribution plan that makes sense for their particular situation.
For more information on planning strategies related to the 10-year rule see “Distribution planning under the SECURE Act.”
WHAT ARE THE RISKS?
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