Confusion Reigns - STILL - Over 10-Year Inherited IRA Rule
Almost exactly two years ago, I wrote about the confusion sown by the IRS among taxpayers who have inherited IRAs from a non-spouse. This confusion stems from the IRS's ruling regarding the so-called "10-Year" distribution rule for IRAs that have been inherited by beneficiaries who were not a spouse of the IRA owner.
Prior to 2020, if you inherited an IRA from someone, spouse or otherwise, you had great flexibility as to when to take distributions from it. While you would be required to take annual required minimum distributions (or RMDs) of some amount, if you so desired, those distributions could be taken out over your entire life expectancy. Quite literally, for someone relatively young, the RMDs could stretch over decades, thus this became known as the "stretch IRA" planning technique.
This all changed with passage in 2019 of the SECURE Act. While a spousal beneficiary could still take advantage of this rule, non-spouse beneficiaries (with a few exceptions) were generally required to drain the IRA over no more than a 10-year period. This effectively ended the lifetime stretch option for most non-spouse beneficiaries.
Initially, it was generally believed by most tax advisors that as long as the IRA was completely drained by the 10-year mark, it didn't matter when or how frequently distributions were actually taken. In other words, annual distributions wouldn't be required. You could take a distribution in some years, skip others, or even wait and take it all in year 10, whatever made the most sense for you, giving you maximum planning options.
Even the IRS initially indicated, in non-authoritative guidance given via IRS Publication 590-B, that annual RMDs were not mandatory under the 10-year rule.
All that changed in 2022 when the IRS issued proposed regulations that caught us by surprise. Under these regulations, if you inherit a traditional IRA from someone who had already passed their required beginning date and had begun talking their RMDs, you can no longer wait and take distributions whenever you please. Instead, in years 1 through 9, you must take annual RMDs yourself, with the balance being taken in year 10.
The consequences of failing to take an RMD are harsh. In normal circumstances, when someone fails to take an RMD, the correction is to, as quickly as possible, take a distribution in an amount equal to all RMDs that were not taken but should have been. Further, because such a failure is subject to an onerous 50% failure penalty, a Form 5329 should be filed to report the penalty, and either pay it or request a hardship waiver.
Fortunately, the confusion surrounding this was so great that the IRS heeded calls to provide relief, and previously waived penalties for failure to take an RMD through 2023. Now, the IRS recently announced that it was extending the waiver through 2024 as well. So, if you find yourself in this predicament, you can breathe easier, at least for now.
Many experts believe the IRS overstepped its interpretive bounds here, claiming that they are not in keeping with the statute that made these changes. Because they were proposed regulations, they could still be changed when the "final" regulations are ultimately issued. So, is this latest announcement an indication that the IRS may be rethinking its position?
Apparently not. In the same IRS notice that announced the latest penalty waiver, the IRS also made if clear that the "final regulations that the Department of the Treasury (Treasury Department) and the Internal Revenue Service (IRS) intend to issue related to RMDs will apply for purposes of determining RMDs for calendar years beginning on or after January 1, 2025."
So, there you have it. For now, you still have some planning flexibility if you are subject to the 10-year rule and don't have to worry about penalties. However, keep in mind that simply delaying the taking of distributions as long as possible may not be the best plan for everyone. If the IRA balance is large enough, it may make sense to take distributions in smaller chunks over time, if doing so will keep you from being pushed into a higher tax bracket, as might be the case with taking fewer but larger distributions.
It should be noted that when the deceased has not yet reached their required beginning date for taking RMDs, the beneficiary still has the flexibility to wait and time the distributions as they see fit (again, as long as it is eventually all taken within the 10-year period).
