IRS Clarifies 10-Year Rule for Retirement Account Beneficiaries

The IRS recently issued guidance on the annual distributions for beneficiaries of retirement accounts. The 10-Year Rule for inherited retirement accounts was created as part of the SECURE Act, which was signed into law on December 20, 2019. The 10-Year Rule generally requires that beneficiaries of inherited IRAs and other retirement accounts must withdraw the entire balance by the end of the tenth year following the account holder’s death. This rule replaced the previous “stretch IRA” provisions, which allowed non-spouse beneficiaries to extend distributions over their lifetime.

The provisions of the SECURE Act, including the 10-Year Rule, generally took effect on January 1, 2020. This rule applies to beneficiaries who inherit retirement accounts from individuals who passed away on or after that date. What was not clear was if the beneficiaries had to take annual distributions from the accounts during the ten-year period or if the account just needed to be distributed by the tenth year. The answer lies in the decedent’s age and situation.

Annual Distribution Requirements

A 10-year beneficiary must make annual distributions if they inherit a retirement account after 2019 and the decedent passed on or after their Required Beginning Date (RBD) or was taking life expectancy distributions. Basically, if the decedent was subject to distributions before they passed, then the beneficiary who inherits the account must make annual distributions of a minimum amount based on their life expectancy. They still must distribute the entire account by year ten.

Distribution Strategy

Depending on the size of the account and your other income, it may make sense to take a larger amount each year to minimize taxes over the whole time period. An example may help.

Let’s assume Jane is 46 and inherits a $500,000 IRA from her father, who was 78 in 2023 when he died. Since her father was past his RBD date, Jane must make annual distributions based on her life expectancy at a minimum of around $12,500. She must distribute the entire account before December 31, 2033. Therefore, if she took the minimum amount each year, that would only be around $125,000. She would still need to distribute the remaining $375,000. This is where she can work with an accountant or her financial advisor to consider the other income in each of the 10 years and maybe distribute more to spread the taxes out each year.

Pre-RBD Inheritance

If a beneficiary inherits the account prior to the decedent reaching their RBD date, then they are not required to make distributions annually. However, just as the example outlined above, they may want to take distributions to spread the taxes over several years depending on their other income.

Roth Inherited Accounts

Roth inherited accounts will also follow the pre-RBD date rule as the decedent is not subject to RMDs. However, the beneficiary still must distribute the entire account by year ten although not taxable. If you don’t need the cash flow, it may make sense to keep the account invested and allow it to grow tax-free for 10 years and then take it out at the end.

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