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The IRS has finally issued long-awaited regulations on how required minimum distributions (RMDs) should be calculated for inherited qualified retirement plans and IRAs. These new rules, released in July 2024, are a critical update for account participants, owners, and their beneficiaries, particularly for those who have inherited accounts after the original account holder had already begun taking RMDs.
Here’s what business owners need to know about these changes and how they can impact their financial and estate planning:
Required Minimum Distributions (RMDs) Overview
RMDs are withdrawals that must be taken from tax-deferred retirement accounts, such as IRAs or 401(k) plans, after reaching a certain age. For most account holders, RMDs must begin by April 1 of the year following the year you turn 73. These distributions are taxed at ordinary income tax rates, which can go as high as 37%. If you fail to take the required distribution, the penalty has been significantly reduced by the SECURE 2.0 Act, from 50% to 25%, and can drop to 10% if corrected promptly.
For business owners with retirement accounts, keeping track of these dates is essential to avoid unnecessary penalties and ensure proper tax planning.
What Changed with Inherited Accounts?
In the past, beneficiaries of retirement accounts, especially those who inherited traditional IRAs, had favorable rules allowing them to “stretch” RMDs over their lifetime, sometimes for decades. This approach was beneficial because it spread out the tax burden over a longer period, keeping the annual taxable income relatively low. However, the SECURE Act changed the game. Now, most beneficiaries must withdraw the entire account balance within 10 years after the original account holder’s death.
There’s an exception for certain beneficiaries classified as “eligible designated beneficiaries” (EDBs). This group includes:
- Surviving spouses
- Minor children (until they reach the age of majority)
- Disabled or chronically ill individuals
- Beneficiaries not more than 10 years younger than the deceased account owner
These EDBs can continue to use the “stretch IRA” strategy, allowing them to spread RMDs over their lifetime, providing more flexibility and continued tax deferral.
Non-EDBs Face New RMD Requirements
For non-EDBs (those who don’t qualify for the exceptions), the rules are stricter. Initially, it was unclear whether these beneficiaries needed to take RMDs annually within the 10-year period or if they could wait until the 10th year to withdraw everything. The IRS has now clarified that if the deceased account owner had already begun taking RMDs before passing, the non-EDB beneficiaries must continue taking annual RMDs over the 10-year period.
For example, if you inherit an account from someone who had already started taking RMDs, you will need to take annual distributions starting in 2025, continuing for 10 years. This phased withdrawal might result in larger taxable amounts each year since the account balance would be growing for the first few years without any withdrawals.
Practical Implications for Business Owners
As a business owner, these new regulations on inherited accounts might affect your estate planning, especially if you plan to pass on your retirement savings to beneficiaries who don’t fall under the EDB category. Without careful planning, your beneficiaries could face larger tax burdens over a compressed time period. Here are some key strategies to consider:
- Maximize Roth IRA Contributions: Since Roth IRAs aren’t subject to RMDs while the original account holder is alive, converting some of your traditional IRA funds into a Roth IRA could be a smart move, especially if you expect to bequeath the account. This can provide your beneficiaries with tax-free income and avoid the complications of RMDs entirely.
- Consider Gifting Strategies: If you’re concerned about the tax impact on your beneficiaries, consider gifting assets outside of your retirement accounts. Gifting while you’re still alive can help reduce the size of your estate and provide immediate financial support without triggering the complications of RMDs.
- Work with Financial and Tax Advisors: Navigating the new RMD regulations can be complex, especially when factoring in the 10-year rule and the exceptions for EDBs. Collaborating with financial advisors who understand the latest tax laws can help you structure your retirement accounts to minimize tax liability for your heirs.
Final Thoughts
The new IRS regulations for inherited accounts mark a significant shift in how RMDs must be handled. Business owners who have accumulated substantial retirement savings should review their estate plans to ensure their beneficiaries are not hit with unexpected tax burdens. With careful planning, you can still achieve tax-efficient wealth transfers, but staying informed and proactive will be key as these regulations come into play starting in 2025.
As always, be on the lookout for additional guidance from the IRS as these rules continue to evolve.
