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The SECURE Act of 2019 eliminated the “stretch IRA,” where children could continue to defer taxes on IRA balances inherited from parents, even passing them on to grandchildren. This had allowed for decades of tax-free asset growth. Congress decided to curtail the deferral past spouses by requiring that IRAs passed to non-spouses be fully distributed at the end of 10 years, with a few exceptions.
Confusion has arisen regarding whether all amounts must be withdrawn annually or “cleaned out” in year 10. The IRS added to the confusion by offering different interpretations after the law was enacted. To address this confusion, the IRS responded by not penalizing IRA beneficiaries who failed to take distributions while the rules are finalized.
The IRS proposed rules require that annual distributions continue if the original IRA owner had begun taking required minimum distributions (“RMDs”), while allowing beneficiaries of IRA owners who had not begun taking RMDs to choose to take some distributions or wait until the 10th year.
An heir will need to plan to minimize the tax hit. For example, they may be able to keep their total income in a lower tax bracket. The simplest approach may be to just take 1/10th each year, so they do not end up in a higher bracket. This may not be best if the beneficiary’s income has significant changes for bonuses, major stock sales, taking their own RMDs or starting social security. We reviewed possible strategies with Harold Hallstein IV of the Sankala Group who said that, surprisingly, someone in a low tax bracket who expects to be in a higher bracket in the future may benefit from taking the account balance right away, thereby availing themselves of long-term capital gains rates on future investment growth.
One note of caution: beneficiaries need to be sure to set up the inherited IRA account and not take a check, as that will be fully taxable.