Getting the right tax advice and tips is vital in the complex tax world we live in. The Kiplinger Tax Letter helps you stay right on the money with the latest news and forecasts, with insight from our highly experienced team (Get a free issue of The Kiplinger Tax Letter or subscribe). You can only get the full array of advice by subscribing to the Tax Letter, but we will regularly feature snippets from it online, and here is one of those samples…
Tax Letter readers are especially interested in IRAs. One topic that has come up a lot lately, judging by the questions we get, is inherited IRAs.
A December 2019 law curbed the popular stretch IRA strategy for non-spouse beneficiaries. Before the original SECURE Act, IRA owners who died were able to leave their accounts to their children, grandkids, or other non-spouse individual beneficiaries, and heirs could stretch required minimum distributions (RMDs) over their own lifetimes, thus allowing the funds in the accounts to grow tax-free for decades. Congress saw this as a loophole for the rich and curtailed it four years ago by enacting the 10-year cleanout rule.
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10-Year-Clean-Out Rule for Inherited IRAs
Many IRAs inherited after 2019 are subject to the 10-year cleanout rule. The IRA funds must be distributed to beneficiaries within 10 years of the owner’s death. There are some exceptions for beneficiaries who are surviving spouses or minor children of the account owner, or beneficiaries who are chronically ill, disabled, or not more than 10 years younger than the deceased IRA owner. For minor children, the exception applies only until the child reaches age 21. The rule for spouses didn’t change. Unlike other beneficiaries, a surviving spouse still has the option to take an inherited IRA as his or her own. Also, the old rules still apply for people who inherited IRAs before 2020, so that they can continue to take advantage of the stretch IRA strategy.
How does the 10-year cleanout rule work? Must amounts be paid out each year or can the beneficiary wait until year 10 to take out all the money? This question is sowing lots of confusion. The IRS’s original interpretation of the rule led many tax and retirement professionals to believe that it doesn’t mean that annual payouts to beneficiaries are required. It was thought that beneficiaries could wait until year 10 to take out all the money, get annual payouts or skip years, provided that the IRA is fully depleted within 10 years after the original owner’s death.
Proposed Regulations for Inherited IRAs
The IRS issued proposed regulations in March 2022 that muddied the waters. Under the regulations, the 10-year cleanout rule differs based on whether the original IRA owner dies before or after his or her first beginning date for taking RMDs. If he or she died before, then the beneficiaries needn’t take distributions from the IRA each year. Instead, these beneficiaries can take annual distributions, they can wait until year 10 to take out all the money, or they can skip years, provided the IRA is fully depleted within 10 years. Tax and retirement professionals are fine with this provision. It’s the following that surprised them. If the deceased IRA owner died after the RMD start date, then annual RMDs must be paid to the beneficiary in years 1 through 9, with the rest of the account fully depleted by year 10. In this situation, the beneficiary would figure annual RMDs based on his or her life. So the younger the beneficiary, the smaller the RMD amounts. Of course, the beneficiary can take more than the RMD amount each year and can clean out the account before year 10 if he or she desires.
The IRS’s proposal on the 10-year cleanout rule, which has not yet been finalized, has received lots of criticism. Practitioners want the 10-year rule to apply on a consistent basis, without regard to whether the IRA owner dies before or after the RMD beginning date.
Meanwhile, the IRS is giving relief. Last October the IRS said that beneficiaries of IRAs inherited after 2019, for which the deceased owner was already subject to RMDs, won’t be penalized for not taking distributions in 2021 or 2022. The IRS just extended that relief for such beneficiaries for 2023.
This first appeared in The Kiplinger Tax Letter. It helps you navigate the complex world of tax by keeping you up-to-date on new and pending changes in tax laws, providing tips to lower your business and personal taxes, and forecasting what the White House and Congress might do with taxes. Get a free issue of The Kiplinger Tax Letter or subscribe.
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FAQs
Last October the IRS said that beneficiaries of IRAs inherited after 2019, for which the deceased owner was already subject to RMDs, won't be penalized for not taking distributions in 2021 or 2022. The IRS just extended that relief for such beneficiaries for 2023. This first appeared in The Kiplinger Tax Letter.
Does the 10-year rule apply to inherited IRA? ›
Some beneficiaries of IRA accounts whose owners died in 2020 or later are exempted from the 10-year rule. This exemption applies to "eligible designated beneficiaries," who can be: A surviving spouse. A disabled or chronically ill person.
What are the new rules for inherited IRAs in 2024? ›
The latest IRS update says those heirs won't incur a penalty for missed RMDs for inherited accounts in 2024. But they still must empty the account by the original 10-year deadline.
How do I avoid paying taxes on an inherited traditional IRA? ›
Spouses can rollover funds from an inherited traditional IRA into an existing or new traditional IRA in their name and treat the inherited funds as their own. This allows them to delay paying taxes until they reach retirement age and begin taking required minimum distributions (RMDs).
What is the IRS 10-year rule? ›
The IRS generally has 10 years – from the date your tax was assessed – to collect the tax and any associated penalties and interest from you. This time period is called the Collection Statute Expiration Date (CSED). Your account can include multiple tax assessments, each with their own CSED.
How do I avoid the 10 year rule for an inherited IRA? ›
An eligible designated beneficiary is exempt from the 10-year rule by falling into one of the following categories: the surviving spouse of the account holder. a child under age 21 of the account holder. a disabled or chronically ill person.
Will I get a 1099-R for an inherited IRA? ›
The Internal Revenue Service provides guidelines for inherited IRA beneficiaries. 1 IRS forms 1099-R and 5498 are required for reporting inherited IRAs and their distributions for tax purposes. Inherited IRAs are treated the same, whether they are traditional IRAs or Roth IRAs.
When did the 10 year inherited IRA rule change? ›
The 10-year rule applies to those who have inherited an IRA on or after Jan. 1, 2020. The inherited IRA 10-year rule changed the way this type of account is handled when it passes from one account holder to another. It came into effect by way of the SECURE Act, which passed in December 2019 and became law as of Jan.
What is the SECURE Act 2.0 10 year rule for inherited IRAs? ›
The passage of the SECURE Act means that most nonspouse beneficiaries who inherit IRA assets on or after Jan. 1, 2020, are required to withdraw the full balance of the account within 10 years. This includes adult children and grandchildren and most other designated beneficiaries.
Do I need to take an RMD from an inherited IRA in 2024? ›
Roth IRAs do not require withdrawals until after the death of the owner. Designated Roth accounts in a 401(k) or 403(b) plan are subject to the RMD rules for 2022 and 2023. However, for 2024 and later years, RMDs are no longer required from designated Roth accounts.
Defer, defer, defer. This is typically a sound tax management strategy. In the context of inherited IRAs, this approach would lead beneficiaries to wait until the end of the 10-year window to distribute the account. By doing so, they can defer taxes on both earnings and withdrawals.
How much tax will I pay if I cash out an inherited traditional IRA? ›
Those who inherit an IRA and who take distributions from it are taxed on the withdrawn income at their ordinary tax rate, regardless of whether the estate was subject to estate tax or not.
What is the best thing to do with an inherited IRA? ›
Treat the IRA as if it were your own, naming yourself as the owner. Treat the IRA as if it were your own by rolling it over into another account, such as another IRA or a qualified employer plan, including 403(b) plans. Treat yourself as the beneficiary of the plan.
Why is the IRS trying to collect after 10 years? ›
In some cases, the IRS can take more than 10 years to collect tax debts. This happens when an event causes the clock to stop ticking on the statute of limitations and the deadline gets extended. This is called tolling the statute of limitations.
What are the exceptions to the IRS 10 year statute of limitations? ›
Statute of Limitations on Tax Assessments
This tax assessment statute of limitations can be extended or suspended in certain situations, such as if a taxpayer doesn't file a tax return, files for bankruptcy, or reports 25% or less of their income on a tax return.
Do I have to report an inherited IRA on my tax return? ›
However, distributions from an inherited traditional IRA are taxable. This is referred to as “income in respect of a decedent.” That means if the owner would have paid tax, the income is taxable to the beneficiary. If you inherit the IRA from your spouse, you have the option to treat the IRA as your own.
What are the tax rules for an inherited IRA? ›
Withdrawals of contributions from an inherited Roth are tax free. Most withdrawals of earnings from an inherited Roth IRA account are also tax-free. However, withdrawals of earnings may be subject to income tax if the Roth account is less than 5-years old at the time of the withdrawal.
How many years do you have to take an inherited IRA? ›
Generally, a designated beneficiary is required to liquidate the account by the end of the 10th year following the year of death of the IRA owner (this is known as the 10-year rule).
How long do you have to pay taxes on an inherited IRA? ›
Instead, you have just 10 years from the time you inherited the account to withdraw and pay taxes on the entire amount. Exceptions apply if you are disabled, chronically ill or an underaged child. Another exception applies if you are less than 10 years younger than the original owner of the IRA.
