Ten-year Rule

Answer: The IRS outlined regulations that went into effect January 1, 2025, regarding the 10-year distribution rule for designated beneficiaries. The 10-year rule was designed to standardize the amount of time inherited IRA money could grow tax-deferred. The new rules could impact your wealth and wealth transfer planning.  

The 10-year rule requires most non-spouse beneficiaries to withdraw the entire balance of an inherited IRA within 10 years. It also set parameters around timing, distributions, and beneficiary categories. Here are key guidelines and terminology. 

RMDs (required minimum distributions) are the amount that must be withdrawn from a retirement account each year after the account owner reaches the designated age.                 

RBD (required beginning date) is the date by/on which the first RMD must be taken. This date is April 1 of the year after an IRA owner reaches their applicable RMD start age (currently 73). 

EBD (eligible beneficiary distribution) applies to beneficiaries who may take distributions over their life expectancy but may also choose to apply the 10-year rule, depending on their situation, including Spouses, Individuals not more than 10 years younger than the retirement plan account or IRA owner (this includes an individual older than the IRA owner), minor children of the retirement plan account or IRA owner only (note: these must be children of the account owner – not a grandchild, niece, nephew, etc. – and after they reach age 21, the account must be depleted within 10 years), disabled individuals, or chronically ill individuals. 

NEBDs (non-eligible designated beneficiaries) are beneficiaries who are subject to the 10-year rule, including those not falling into any of the above groups, who inherited from someone who died before their RBD. Those not falling into any of the above groups, who inherited from someone who died after their RBD.  

The changes will have the biggest impact for beneficiaries of larger accounts, compounded when/if the beneficiaries are successful themselves and taxed at higher rates. This compressed time period could force distributions into higher tax brackets. Before the 10-year rule, the ‘stretch IRA’ strategy allowed distributions and the tax impact to inheritors to spread across their life expectancies. While that possibility is much more limited now, there are alternative strategies for maximizing IRA funds in line with current regulations. Here are a few considerations: 

Roth conversion: Converting a traditional IRA to a Roth IRA may keep those converted dollars at a lower tax bracket than if they were forced to take it as an RMD from a Traditional IRA later. Converted dollars and earnings will be tax-free to the owner and ultimately to a beneficiary, provided several conditions are met.  

Withdrawals from tax-deferred accounts may be subject to income taxes, and prior to age 59.5 a 10% federal penalty tax may apply. Converting a traditional IRA into a Roth IRA may involve additional taxation. When converted to a Roth, federal income taxes are paid on the converted amount, but no further taxes in the future. Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Each converted amount is subject to its own five-year holding period unless the owner is 59.5 or older. 

Life insurance: A more involved planning strategy is to offset taxes by using funds from a pre-tax retirement account to purchase life insurance, naming the beneficiary as the same person who’ll inherit their retirement account.  

How a beneficiary inherits determines how rules are applied and how RMDs are managed. If the account owner dies before their RBD a non-eligible beneficiary will need to deplete the account by December 31 of the tenth year following the owner’s death but will not have to take RMDs. If the account owner dies after their RBD a non-eligible designated beneficiary will need to take RMDs in years one through nine, with a final distribution in year 10. This RMD requirement is generally based on the single life expectancy of the beneficiary.  

Missed RMDs: Because final guidance regarding the 10-year rule has been shared four years after the rule’s introduction, in many of these cases, the IRS is issuing waivers for missed RMDs. This waiver only applies to non-eligible designated beneficiaries under the 10-year rule who inherited from an IRA owner who died after their RBD. 

Timing: Strategic planning if beneficiaries are in higher tax brackets may be beneficial. If a beneficiary plans to retire five years after inheriting, consider taking minimum distributions while still working and increase payments to deplete the account in their first five years of retirement. 

Because of the complexity, collaborate closely with your financial advisor and, when appropriate, experienced estate planning and tax professionals. Stay focused and plan accordingly.  

https://www.raymondjames.com/commentary-and-insights/retirement-longevity/2024/10/23/the-ins-and-outs-of-nonqualified-deferred-compensation Raymond James & Associates, Inc., member New York Stock Exchange/SIPC. The opinions expressed are those of the writer as of December 29, 2024,  but not necessarily those of Raymond James and Associates, and subject to change at any time based on market conditions and other factors. Raymond James nor its advisors provide tax or legal advice.