A Required Minimum Distribution (RMD) is the minimum amount individuals must withdraw annually from their own traditional retirement accounts, such as IRAs or 401(k)s once they attain their Required Beginning Date (RBD). This requirement ensures that retirement savings are not indefinitely sheltered from taxation. Distributions from traditional IRAs and retirement plans are usually taxed by the federal and state authorities at the owner’s ordinary income tax bracket in the year of the withdrawal. The annual RMD amount is calculated by dividing the plan balance as of December 31st of the prior year by that individual’s life expectancy factor (provided by the IRS).

Prior to passage of the SECURE 2.0 Act (Dec. 2022), the RBD to start RMDs was age 72 for retirement accounts, including traditional IRAs and 401(k)s. The law brought changes to the RMD in two phases. First, the RMD age increased to 73 in 2023. In 2033, the RMD age will further rise to 75. Individuals born between 1951 and 1959 must start their RMDs no later than April 1st following the calendar year in which they attain age 73. For most taxpayers, optimum income tax planning occurs by beginning RMDs within the calendar year in which they attain age 73. Those born in 1960 or later can delay RMDs until after age 75.

SECURE Act 2.0 enacted significant changes to the governing of inherited IRAs as well, reshaping the landscape for beneficiaries of IRAs and retirement plans. The revamped rules aim to accelerate the distribution of inherited retirement funds, impacting beneficiaries in various ways based on their relationship with the original account holder.

It’s crucial to note that these changes exclusively apply to IRAs inherited after January 1, 2020, subject to special Congressional Exemptions permitted in calendar years 2020, 2021 & 2022 due to COVID-19. For individuals who passed away before January 1, 2020, the RMD rules for beneficiaries still use the former rules – which typically stipulated withdrawals under a 5-year distribution rule or based on the life expectancy of the designated beneficiary. The life expectancy calculation is referred to as a “stretch” provision because it enabled beneficiaries to extend the distribution period and potentially minimize the tax impact on inherited retirement accounts.

To determine the RMD rules applicable to individuals who inherit IRAs or retirement accounts post-January 1, 2020, start with the following questions:

What classification does the beneficiary fall under? This will be based on several factors including their relationship to the deceased original owner.

  • Eligible Designated Beneficiaries (EDB): This category includes surviving spouses, minor children, individuals with disabilities or chronic illnesses, and a person not more than 10 years younger than the IRA account owner.
  • Non-Eligible Designated Beneficiaries (Non-EDB): Defined as any individuals named as beneficiaries on the retirement account not classified as EDBs.
  • Non-Designated Beneficiaries: This group comprises non-individuals or entities like estates, trusts, charities, and other organizations.

Did the original account owner die prior to their Required Beginning Date (RBD)? If they passed away prior to April 1st of the year they were required to begin taking RMDs; they passed away “pre-RBD”. If they passed on or after April 1st of the year, they were required to begin taking RMDs; they passed away “post-RBD”.

EDBs can still utilize a modified life expectancy method (stretch IRA rules), spreading distributions over their expected lifespan (subject to certain restrictions). Spousal beneficiaries also have the option to treat the IRA as their own, delaying RMDs until they reach 73.

Non-EDBs must adhere to a stricter distribution timeline, completing the entire distribution within ten years (10-year rule) of the original account holder’s passing. Additionally, non-EBDs who inherit “post-RBD,” must calculate and withdraw an RMD amount in each of the first 9 years after the original depositor’s passing until finally distributing the entire account balance by the end of the 10th anniversary year. The first 9 annual withdrawals are based on the single life expectancy of the beneficiary or the original account owner, whichever is longer.

Non-Designated beneficiaries also adhere to different rules if the original IRA owner was required to take RMDs at the time of their death. If they inherit pre-RBD, then the 5-year rule applies, and all assets must be fully distributed by the end of the fifth year after the original IRA owner’s year of death. If they inherit post-RBD, RMD distributions are required based on the single life expectancy of the original IRA owner.
Understanding these distinctions is vital for effective financial planning. Beneficiaries must carefully assess their relationship with the account holder and the implications of the new rules. Failure to take an RMD or distributing too little can be subject to a 25% penalty of the amount that should have but was not withdrawn.

The SECURE Act 2.0 has reshaped the landscape of inherited IRAs, impacting the distribution strategies available to beneficiaries. Beneficiaries of IRAs and retirement plans should consult with a financial advisor or tax professional to assist them in understanding and complying with these regulations. Since the SECURE Act of 2019 and the SECURE Act 2.0 became law, Eagle Ridge investment professionals have helped numerous clients navigate the evolving regulatory landscape and implement an income tax efficient retirement plan that addresses their unique needs.