If you have a traditional IRA that you’ve paid into over the years, the required minimum distribution (RMD) rules are relatively straightforward: you have to start taking distributions by April 1 of the year after you turn 72, and your minimum distribution is determined by taking your account balance at the beginning of the year and dividing it by your statistical life expectancy (determined using IRS tables).

But if you inherit an IRA from someone else, then determining when you have to start taking distributions and how much you must take becomes ridiculously complex and depends on multiple factors. The main ones include:

1. What sort of beneficiary you are. Rules are most generous for those who inherited the IRA from a spouse. For non-spousal beneficiaries, there are two separate sets of rules: one for “eligible designated beneficiaries” and another for all other beneficiaries. In most cases, if you’ve inherited the IRA from a parent, you won’t be considered an eligible designated beneficiary, so you’ll be subject to the least generous provisions (i.e., you’ll have to take distributions more quickly).

2. How old the original owner was when they died. In general, if the original IRA owner died before they reached the required starting age for distributions (currently 72, previously 70 ½, and possibly going up to 75 under some proposed legislation), the rules are more generous than if they died after reaching the required starting age.

3. The year the original owner died. Congress made significant changes in the RMD rules for inherited IRAs in the SECURE Act near the end of 2019. Inherited IRAs have one set of rules for IRAs inherited from decedents dying in 2019 and earlier. There’s a separate set if the original owner died in 2020 or later.

A full discussion of the RMD requirements for inherited IRAs would fill a small book (or maybe a not-so-small book). But there is one common scenario where the rules have changed that taxpayers may not be aware of.

One of the SECURE Act provisions was a ten-year rule for an IRA inherited from decedents who a) died in 2020 or later and b) had already reached the required starting age for IRA distributions prior to death. The rule stated that non-eligible designated beneficiaries had to have the entire IRA distributed to them within ten years of the year the original holder died.

So as an example, assume James is 45 and inherits an IRA from his 77-year-old mother in 2022. Unless James is either disabled or chronically ill, he is not an eligible designated beneficiary. He has to take the entire IRA account as distributions by 2032, the tenth year after the year his mother died.

Because of the way the law was written, and because of some earlier IRS publications, most accountants had assumed that James could have taken his distribution(s) however he liked, including taking the entire amount in 2032, as long as he empties the IRA by the end of 2032.

Recent proposed regulations, however, would require that James take a minimum distribution every year beginning in 2023 (or possibly beginning in 2022 if his mother died before taking her RMD for 2022), with any remaining balance to be taken in 2032 (the tenth year). James’ RMDs in years one through nine are based on his own life expectancy. Any remaining balance must be taken by the end of year ten. James may, of course, choose to take more than the RMD in any year.

Taxpayers who aren’t aware of these particulars can face severe consequences. The failure to take the RMD is subject to a 50% excess accumulation penalty on the shortfall. So if James would be required under the new rules to take a $12,000 distribution in 2023 and takes only $5,000, his penalty would be 50% of the excess of the RMD over the actual distribution. In other words, he’d be subject to a $3,500 penalty (50% of ($12,000 – $5,000). If James didn’t take any distribution at all, he’d be subject to a $6,000 penalty.

At this point, the regulations are still proposed, and it’s possible that the final regulations will have less restrictive requirements. But taxpayers who inherit an IRA need to be aware and need to understand what the requirements are for their particular situation. If you’ve inherited an IRA, you’ll likely want to speak to your tax advisor before the end of the year, to have time to take any required distributions.

 

By Greg Yoder

 

Update: In response to taxpayer concerns over the proposed regulations, the IRS issued Notice 2022-53.  The notice provided that final regulations would not be effective until at least 2023 and suspended any penalties for taxpayers and retirement plans who didn’t comply with the new rules.  That means that most owners of inherited IRAs won’t need to take a distribution until 2023.  Depending on your tax situation, it may still be beneficial to take a distribution in 2022 in order to avoid having to take a larger distribution next year.  Check with your tax advisor.