Inherited IRAs are subject to numerous rules.

Individual Retirement Accounts (IRAs) are foundational financial tools for retirement planning.

They allow you to set aside and invest pre-tax money that grows tax-deferred so you can have an income stream after you have retired from employment.

In addition, at one time, retirement accounts were wonderful tools for intergenerational wealth transfer.

According to a recent Kiplinger article titled “IRS 10-Year Rule for Inherited IRAs: Kiplinger Tax Letter,” the estate planning benefits diminished significantly when the SECURE Act became law.

Minor children who inherit IRAs need not begin draining the account until they become legal adults.

With this law, Congress created a 10-year clean-out rule and complicated how retirement accounts are handled when inherited.

What is the 10-year clean-out rule?

The rule essentially requires all inherited IRA funds to be withdrawn within ten years of the death of the original owner.

Although Congress may have believed this straightforward, many people are confused regarding the practical applications and possible exceptions.

Truth be told, it even confuses estate planning attorneys, financial advisors, and CPAs who are consulted to advise their clients on all the moving parts in play.

The exemptions from this 10-year clean-out rule are very limited.

What are they?

Beneficiaries who are exempt from draining the account within ten years are the surviving spouse, the minor children of the account owner, and heirs who are disabled, chronically ill, or fewer than ten years younger than the original owner of the account.

For minor children, the exemption ends no later than when they reach the age of majority under state law.

Depending on the state, this age will typically be 18 or 21.

Once they reach the applicable age of majority, these newly minted adult beneficiaries have ten years to withdraw all funds from the account.

For surviving spouses, the accounts can be treated as their own accounts.

Do those who inherited IRAs before 2020, when the SECURE Act took effect, need to drain the accounts?

No.

These individuals will find they are subject to the original rules.

As a result, they can continue benefiting from the stretch IRA strategy.

For those who are subject to the new IRA rules, how must they comply with these guidelines?

People have specifically wondered whether equal amounts must be taken each year from the inherited IRAs, whether annual withdrawals are required, and whether it is possible to delay withdrawals until the tenth year.

More questions arose when the IRS proposed new rules in March 2022, depending on whether the original owner of the IRA died before or after Required Minimum Distributions (RMDs) were initiated.

This new rule states beneficiaries of IRAs can take intermittent withdrawals as long as the account is depleted in 10 years unless the original owner had been taking Required Minimum Distributions before death.

What does this mean?

Those who inherit an IRA where RMDs had begun must take RMDs based on their life expectancy for the first nine years after the inheritance and then completely drain the account on year 10.

Younger heirs would be required to take smaller RMDs, while older heirs would take larger ones.

The IRS has yet another proposal for the new IRA rules.

The proposed rule involves treating inherited IRA accounts the same whether RMDs were initiated or not before the death of the original owner.

Those who have been confused by the rule and inherited an IRA after 2019 will find some relief in a decision made by the IRS in October 2022.

The IRS stated these individuals who inherited accounts subject to RMDs will not be penalized for failing to take distributions in 2021, 2022, and 2023.

If you are confused about how inherited IRAs would affect your loved ones, work with your team of professional advisors: your estate planning attorney, financial advisor, and CPA.

Reference: Kiplinger (July 30, 2023) “IRS 10-Year Rule for Inherited IRAs: Kiplinger Tax Letter”