Understanding the New 10-Year Rule for Retirement Withdrawals
- Contributors
- April Hicks
- Scott Pohar
Aug 28, 2024
Changes in the rules governing required minimum distributions (RMDs) for inherited Individual Retirement Accounts (IRAs) are causing significant shifts in retirement planning. The new 10-year rule, outlined by the Internal Revenue Service (IRS) and reinforced by the SECURE 2.0 Act, alters the landscape for non-spouse beneficiaries of IRAs, making it important to understand these changes and their impact on your estate planning and retirement strategies moving forward.
What is the New 10-Year Rule?
Spouses of the account holder are still eligible for stretching the IRA or retirement account payments out over their lifetime. The new 10-year rule significantly impacts non-spouse beneficiaries who inherit IRAs after the original account holder’s death.
Prior to the SECURE Act, most beneficiaries could stretch required minimum distributions (RMDs) over their lifetime, allowing the funds to grow tax-deferred for an extended period. However, under the new regulations, most non-spouse beneficiaries must fully distribute the inherited IRA within 10 years of the original account holder’s death. There are exceptions to the non-spouse 10-year payout rule “eligible designated beneficiaries”. Periods that are loner than 10 years are available for a child who has not reached the age of majority, a disabled or chronically ill person, or a person who is not more than 10 years younger than the employee or IRA holder.
The 10-year payout rule applies to non-eligible designated beneficiaries—such as adult children, siblings, and other non-spousal heirs—requiring them to withdraw the entire balance within 10 years, regardless of whether the original IRA holder had started taking RMDs before their death.
How the 10-Year Rule Affects Beneficiaries
The new 10-year rule for IRA distributions brings significant changes for beneficiaries, introducing both challenges and opportunities that require careful navigation. This is especially true when the IRA or retirement beneficiary is a trust.
Among the ways in which beneficiaries will be affected are:
Increased Tax Burden: The requirement to withdraw the entire balance within a decade could push beneficiaries into higher tax brackets, especially when compared to the previous option of spreading distributions over many years. If the designated beneficiary is a trust, the trust may pay tax at an even higher rate than the individual beneficiary should they have gotten the IRA/retirement distribution out right.
Flexibility Without Annual RMDs: While annual RMDs are not required under the 10-year rule, beneficiaries must still ensure the entire balance is withdrawn within the 10-year period or face a steep excise tax on any remaining balance.
Exceptions for Spousal and Eligible Designated Beneficiaries: Spousal beneficiaries and certain other eligible individuals can bypass the 10-year rule, continuing to take distributions over their life expectancy and retaining some benefits of the previous system.
Increased Complexity in Estate Planning: The new rule complicates estate planning, necessitating strategic guidance to optimize tax outcomes and avoid penalties. This may involve careful timing of distributions, Roth conversions, or exploring options such as charitable remainder trusts or charitable gift annuities. Because of the added complexity and funding limitations of having a charitable reminder trust or charitable gift annuity as a named beneficiary of an IRA, careful planning with a qualified specialist is needed.
Many families use trusts other than charitable trusts to provide for their families. It’s important to review and possibly revise any trusts set up to receive IRA assets. Since trusts must meet specific requirements to qualify as “eligible designated beneficiaries” under the new rules, proper structuring is essential to avoid unintended tax consequences. By addressing these considerations, individuals can better manage the implications of the 10-year rule and optimize their financial outcomes.
While these annual RMDs must begin in 2025, there will be no penalties for missed RMDs in 2021-2024.
Strategic Considerations for Beneficiaries Affected by the 10-Year Rule
Beneficiaries impacted by the new 10-year rule for IRA distributions should prioritize staying informed, ensuring they thoroughly understand how it affects both IRA account holders and their beneficiaries. This insight is crucial for making informed decisions about estate and retirement planning.
Equally important is developing a well-planned tax strategy. By carefully mapping out a distribution plan that minimizes tax liabilities, individuals and trustees can stagger withdrawals over the 10-year period to avoid significant tax spikes and potentially keep beneficiaries in lower tax brackets. Additionally, considering the conversion of traditional IRAs to Roth IRAs for the original IRA owner could prove beneficial. Although Roth IRAs are also subject to the 10-year rule, their distributions are tax-free, presenting a valuable tax-saving opportunity under the new regulations.
Seek Appropriate Guidance and Support
Ever changing tax laws can be complicated. The finalization of the 10-year rule marks a significant shift in the management of inherited IRAs, making it crucial to stay informed and implement strategic planning to navigate these changes effectively. By understanding the nuances of the rule and its implications, you can make informed decisions that align with your financial goals and help maximize your retirement savings. If you have any questions or need guidance, contact your CRI advisor. We are here to provide the expert advice needed for you to manage these new regulations confidently.