Heirs must act on inherited retirement accounts this year

Recently, we shared new changes impacting retirement accounts beginning in 2025 as provisions of the SECURE 2.0 law continue to be phased in.

An additional key change for this year is related to the original SECURE law. Specifically, as part of the 10-year distribution rule, many beneficiaries of inherited retirement accounts and IRAs must begin taking (at least) a minimum distribution in 2025. This applies to most non-spouse beneficiaries who inherited an account after 2019.

Clarity on the 10-year rule

After several years of uncertainty, the IRS provided clarity last year on how distribution rules apply on inherited retirement accounts. Last fall we highlighted the details about the final regulations in our blog. (See “Unwinding the 10-year rule for inherited retirement accounts.”)

The regulations require that annual, minimum distributions be made on inherited accounts where the original owner passed away after reaching their required beginning date (RBD). In addition, the heir must fully distribute the inherited account within 10 years after the death of the account owner. In the case where the account owner dies prior to reaching the RBD, there is no annual distribution requirement. The inherited account only needs to be fully distributed by the end of the 10-year period. Spouses and other heirs are exempted from the 10-year rule and can stretch distributions based on their remaining life expectancy.*

Annual distributions must begin this year

While the IRS deliberated on the proposed regulations, relief from the annual distribution requirement applied for years 2021 through 2024.

Now, beginning in 2025, many beneficiaries subject to the 10-year rule must begin taking an annual minimum distribution based on their life expectancy. The heir must consult the IRS single life expectancy table (See links to the tables at “Distributions from individual retirement arrangements”) to determine their life expectancy factor. Once determined, they can use that factor to calculate the appropriate distribution based on the value of the account at the end of the previous year. This is the only time the beneficiary consults the IRS table. For each subsequent year, the life expectancy figure is reduced by one.

Planning considerations to mitigate taxes

Heirs subject to the 10-year rule will want to carefully consider how to distribute inherited (traditional) retirement accounts based on several factors, including their personal tax situation. For some, that may entail equalizing distributions over the 10-year period to spread out the taxes that are due. Others may find a benefit from taking a larger share during a few specific years. For example, someone retiring in the middle of the 10-year period may want to take larger distributions after retiring if their income is lower. Depending on the age of the beneficiary, there may be other considerations when taking distributions, such as income limits impacting taxes on Social Security benefits or the amount of Medicare premiums.

Determining the distribution strategy can be complex

It’s important to consult with an advisor on the most beneficial strategy based on individual circumstances. For more information on managing inherited retirement accounts, see our education piece, “Distribution planning under the SECURE Act.”

Endnote:

*The required beginning date is generally April 1 of the year following the calendar year in which the account owner reaches age 73. An exception to the 10-year distribution rule applies to eligible designated beneficiaries (EDBs). These types of beneficiaries include spouses, individuals with disabilities or those who are chronically ill, beneficiaries not more than 10 years younger than the account owner, or minor children of the account owner (up to age 21 upon which the 10-year rule applies). These EDBs have the option to take distributions gradually each year based on their remaining life expectancy.