By Ted Stricker, CFP®
The SECURE 2.0 Act tax legislation provided sweeping changes to retirement account rules, many of which are still being clarified by the IRS. During July, final rulings on inherited IRAs were finally disclosed, and the changes will require added attention and planning by IRA owners, their beneficiaries, and their advisors.
At Bernath + Rosenberg, we’ve been keeping a close eye on these changes and what the final rulings may mean for our clients as well as their tax, financial, and estate planning. Careful attention must be paid to these new rules to avoid unnecessary penalties and taxes, as well as planning opportunities that may arise.
Let’s take a look at how the inherited IRA rules for beneficiaries have changed and evolved over the past several years.
No More “Stretch IRA” Distributions
Prior to 2019, a non-spouse beneficiary was still required to withdraw an annual required minimum distribution (RMD) but could extend (stretch) those distributions over the span of their remaining actuarial lifetime. For younger beneficiaries, this “stretch” provided a beneficial opportunity to continue to grow the account tax-deferred over many years with potentially minimal impact on their own tax situation from year to year.
This all changed with the SECURE Act of 2019. From then on, the “10-year withdrawal window” was introduced for inherited IRAs, meaning beneficiaries were required to completely withdraw (and pay the income taxes) on their inherited IRAs by the 10th year after inheritance. This rule was initially problematic due to the lack of guidance as to whether annual RMDs were required of the beneficiary in years 1-9 or if complete distributions could wait until year 10.
The provisions of SECURE 2.0 in 2022 tried to answer this question, however, distribution requirements for years 1-9 differed as to whether the original IRA owner had begun their own RMDs prior to their death. In July 2024, this 10-year withdrawal deadline was further clarified.
Now non-spouse beneficiaries who do not qualify as eligible designated beneficiaries (EDBs) must not only withdraw the entire account balance of the inherited IRA by year 10, they are also required to withdraw RMDs in years 1-9 if the original IRA owner had reached their RMD age. If the original owner had died before their RMD age, the beneficiary is exempt from the RMD requirement and may withdraw as much or as little as they wish during years 1-9 but still must withdraw the entire balance by year 10.
Those who qualify as EDBs (surviving spouses, minor children, those who are disabled and those who are not more than 10 years younger than the original owner) are not subject to the 10-year rule. While surviving spouses may combine the IRA with their own, the other EDBs may extend their distributions over their own lifetime if they choose.
Avoiding Penalties and Taxes: A Need for Multi-Year Planning
SECURE 2.0 imposes a stiff 25% penalty for missing or not withdrawing enough in a year 1-9 RMD, starting in 2025, as prior waived penalties have ended. The penalty may be reduced to 10% if a correction is made within two years. Each year’s withdrawal is taxable at ordinary income rates (added to the beneficiary’s other taxable income) and if the inherited IRA value is large enough, the annual RMD could subject the taxpayer to higher tax brackets.
This suggests that multi-year and strategic tax planning is a must for most non-spouse beneficiaries of a significant tax-deferred IRA. For many, withdrawing a similar amount each year may spread the tax impact evenly over the 10-year window. But for some, strategic distributions may be needed to achieve other financial planning and tax objectives.
For example, a sudden job loss in a tax year might be an opportunity to withdraw a greater amount from the inherited IRA, both to provide a means to meet expenses, but also to accelerate the drawdown of the inherited IRA without elevating the applicable tax bracket.
Or, in years where college financial aid eligibility is a consideration, a beneficiary’s family may choose to accelerate distributions prior to, or defer more than required distributions until after, eligibility years when a student is attending college. Other strategic years may include those of early retirement, minimizing Medicare premiums, or when making income-based student loan payments.
In other cases, inherited IRA distributions must also be coordinated when considering Roth IRA conversions of the beneficiary’s own tax-deferred IRA or during years of elevated compensation due to performance bonuses, the exercise of stock options, or other instances where taxable income may increase year to year. All this requires a careful, coordinated approach to tax planning in the long run and likely annual reviews with your tax professional.
Inherited Roth IRAs: Similar Rules, but Two Differences
Beneficiaries of Roth IRAs are still subject to the 10-year rule and must fully withdraw their inherited Roth IRA by year 10, but there are two important differences.
First, since Roth IRAs in general do not have RMDs, when to make distributions during the 10-year window is entirely up to the inherited IRA owner. Second, since Roth IRA distributions are not taxable, distributions in any one year have no impact upon the recipient’s tax situation.
The one area where an inherited Roth distribution may be a problem is in college financial aid eligibility. Even though IRA assets (including Roth IRAs) are not countable assets, distributions from Roth IRAs and inherited Roth IRAs are reportable as “untaxed income” on aid application forms for either the parent or student receiving these distributions and could impact aid eligibility.
If this scenario might apply to your family, careful inherited Roth IRA distribution planning is essential to help avoid costly mistakes when applying for college financial aid.
Let’s Have a Discussion About Your Tax and Estate Planning
Multi-year tax planning for taxes and estate planning is a core service at Bernath + Rosenberg, and we’re here to help!
Our experienced team of Certified Public Accountants and CERTIFIED FINANCIAL PLANNER® professionals stays current with the latest in tax laws and financial planning strategies to help you pursue a rewarding and comfortable retirement, save on tax liability, and plan for your family’s future, according to your unique and special objectives.
To get started and make the most of your hard work, schedule a meeting by calling (212) 221-1140 or email tstricker@brwealth.com.
About Ted
Ted Stricker is a partner and financial advisor at Bernath + Rosenberg, a full-service accounting, tax, and wealth management firm with offices in Monsey, NY, Lakewood, NJ, Cedarhurst, NY, and Miami Beach, FL. The firm demonstrates a personalized approach to custom-tailored solutions and an unwavering commitment to client service. With over 26 years of experience in the financial services industry, Ted manages the firm’s wealth management team, and specializes in designing financial plans for business owners and affluent families. Since joining the team in 2015, he provides practical and sound advice, combining innovative approaches and solutions that reflect clients’ personality, lifestyle, and goals.
For the ninth year in a row, Bernath + Rosenberg has been named as one of the leading CPA firms in financial planning by Accounting Today, a publication that receives hundreds of submissions each year and features the Top 150 Firms in the nation. Ted is a CERTIFIED FINANCIAL PLANNER® practitioner and is a member of the Financial Planning Association. To learn more about Ted, connect with him on LinkedIn.
Professionals associated with Bernath & Rosenberg P.C. may be either (1) registered representatives with, and securities and advisory services offered through LPL Financial, Member FINRA/SIPC, a registered investment advisor; or (2) solely tax professionals of Bernath & Rosenberg P.C., and not affiliated with LPL Financial. Tax/accounting/CPA-related services offered through Bernath & Rosenberg P.C. is a separate legal entity and not affiliated with LPL Financial. LPL Financial does not offer tax advice or tax/accounting/CPA-related services.
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