Inherited Retirement Accounts: The 10-Year Rule Explained

If you've recently inherited a retirement account: or might inherit one in the future: you've probably heard about the "10-year rule." While this isn't a brand-new regulation that's turning the estate planning world upside down, it is an important rule that many families are still figuring out.

Let's break down what this rule actually means for you and your family, without all the confusing legal jargon.

What Is the 10-Year Rule?

The 10-year rule is pretty straightforward: if you inherit most types of retirement accounts (like IRAs or 401(k)s), you generally need to empty the entire account within 10 years of the original owner's death.

This rule came into effect on January 1, 2020, through something called the SECURE Act. Before this, beneficiaries could often "stretch" these distributions over their entire lifetime, potentially keeping the money growing tax-deferred for decades. Now, most people have a 10-year window to take everything out.

The deadline is December 31st of the year that contains the 10th anniversary of the account owner's death. So if someone passed away in March 2020, the beneficiary would need to empty the account by December 31, 2030.

Who Does This Apply To?

Here's where it gets a bit more nuanced. The 10-year rule applies to what the IRS calls "designated beneficiaries", basically, individual people who inherit retirement accounts but don't qualify for special exceptions.

However, several groups are exempt from this rule:

Surviving Spouses: If you inherit your spouse's retirement account, you can still roll it into your own IRA or treat it as your own. The 10-year rule doesn't apply to you.

Minor Children: If the deceased's own child inherits the account and is under 21, they're temporarily exempt. But once they turn 21, the 10-year clock starts ticking.

Disabled or Chronically Ill Beneficiaries: These individuals can continue taking distributions based on their life expectancy, but the federal definitions for "disabled" and "chronically ill" are quite strict.

Beneficiaries Close in Age: If you're not more than 10 years younger than the person who died, you're also exempt. This often applies to siblings or friends close in age.

What If You Inherited Before 2020?

Good news: if you inherited a retirement account before January 1, 2020, you're grandfathered in under the old rules. You can continue taking your required minimum distributions based on your life expectancy, and you don't need to worry about any 10-year deadline.

For example, if you inherited your parent's IRA in 2015 and have been taking annual distributions, you can keep doing exactly what you've been doing.

The Annual Distribution Requirement

Here's something that caught many people off guard: depending on when the original account owner died and their age, you might need to take annual minimum distributions during those 10 years, not just empty the account by year 10.

If the original owner had already started taking their required minimum distributions (usually at age 73), then most beneficiaries need to take annual distributions for the first nine years AND empty the account by the 10-year deadline.

The IRS provided some relief for 2021 and 2022, waiving penalties for beneficiaries who missed these annual requirements during the transition period.

Practical Planning Considerations

So what does this mean for your family's financial planning?

Tax Implications: Since you have a compressed timeframe to withdraw everything, you might end up taking larger distributions than you'd prefer. This could potentially push you into higher tax brackets in some years.

Consider spreading distributions somewhat evenly across the 10 years, or coordinate with your tax advisor to time larger withdrawals during years when your other income is lower.

Roth vs. Traditional Accounts: The 10-year rule applies to both, but the tax implications are different. With inherited Roth IRAs, your distributions are generally tax-free, which can make the compressed timeline less painful from a tax perspective.

Estate Planning Impact: The elimination of the "stretch IRA" strategy means retirement accounts are less effective as long-term, multi-generational wealth transfer tools than they used to be.

¿Qué Significa Esto Para Las Familias?

Para nuestros lectores que prefieren español, aquí está lo esencial:

La regla de los 10 años requiere que la mayoría de los beneficiarios de cuentas de jubilación heredadas vacíen completamente la cuenta dentro de 10 años de la muerte del propietario original.

Excepciones importantes:

• Cónyuges sobrevivientes

• Hijos menores del fallecido

• Beneficiarios discapacitados o crónicamente enfermos

• Personas no más de 10 años menores que el fallecido

Consideración clave: Si heredó antes del 1 de enero de 2020, las reglas anteriores aún se aplican a usted.

What Happens If You Don't Follow the Rule?

The IRS doesn't mess around with retirement account rules. If you don't empty the account by the 10-year deadline, you'll face a 25% penalty on the amount that should have been distributed. In some cases, if you correct the mistake quickly, the penalty might be reduced to 10%.

This is why it's crucial to understand which category of beneficiary you are and what your specific requirements entail.

Getting Professional Help

While the 10-year rule isn't as complicated as some other estate planning concepts, the interaction between this rule, your other income, and your overall financial plan can get complex quickly.

Here are some questions to discuss with your financial advisor or tax professional:

• Should you spread distributions evenly or vary them based on your income in different years?

• How will these distributions affect your overall tax picture?

• Are there any state-specific considerations in Georgia?

• Should you consider converting traditional IRA inheritances to Roth accounts?

The Bottom Line

The 10-year rule for inherited retirement accounts has not revolutionized estate planning, but it is an important aspect that affects how families handle inherited retirement savings.

If you've inherited a retirement account since 2020, take some time to understand which category of beneficiary you are and what your specific requirements entail. Don't wait until year nine to figure this out: planning ahead can help minimize the tax impact and ensure you don't miss any important deadlines.

For Georgia families navigating these waters, remember that you don't have to figure this out alone. Whether you're dealing with a recent inheritance or planning for the future, professional guidance can help ensure you're making the most of your options while staying compliant with federal requirements.

¿Necesita ayuda con la planificación patrimonial o cuentas de jubilación heredadas? En ABC Estate Planning, estamos aquí para ayudar a las familias de Georgia a navegar estas decisiones importantes.

The key is understanding your situation, planning accordingly, and not letting the 10-year deadline sneak up on you. With proper planning, you can make this rule work for your family's financial goals.

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The information in this blog post is for educational purposes only and should not be considered legal or tax advice. Always consult with qualified professionals about your specific situation.