IRS 10-Year Rule for Inherited IRAs: Kiplinger Tax Letter

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Tax Letter readers are especially interested in IRAs. One topic that has come up a lot lately, judging by the questions we get, is inherited IRAs.  

A December 2019 law curbed the popular stretch IRA strategy for non-spouse beneficiaries. Before the original SECURE Act, IRA owners who died were able to leave their accounts to their children, grandkids, or other non-spouse individual beneficiaries, and heirs could stretch required minimum distributions (RMDs) over their own lifetimes, thus allowing the funds in the accounts to grow tax-free for decades. Congress saw this as a loophole for the rich and curtailed it four years ago by enacting the 10-year cleanout rule.

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10-Year-Clean-Out Rule for Inherited IRAs 

Many IRAs inherited after 2019 are subject to the 10-year cleanout rule. The IRA funds must be distributed to beneficiaries within 10 years of the owner’s death. There are some exceptions for beneficiaries who are surviving spouses or minor children of the account owner, or beneficiaries who are chronically ill, disabled, or not more than 10 years younger than the deceased IRA owner. For minor children, the exception applies only until the child reaches age 21. The rule for spouses didn’t change. Unlike other beneficiaries, a surviving spouse still has the option to take an inherited IRA as his or her own. Also, the old rules still apply for people who inherited IRAs before 2020, so that they can continue to take advantage of the stretch IRA strategy. 

How does the 10-year cleanout rule work? Must amounts be paid out each year or can the beneficiary wait until year 10 to take out all the money? This question is sowing lots of confusion. The IRS’s original interpretation of the rule led many tax and retirement professionals to believe that it doesn’t mean that annual payouts to beneficiaries are required. It was thought that beneficiaries could wait until year 10 to take out all the money, get annual payouts or skip years, provided that the IRA is fully depleted within 10 years after the original owner’s death. 

Proposed Regulations for Inherited IRAs 

The IRS issued proposed regulations in March 2022 that muddied the waters. Under the regulations, the 10-year cleanout rule differs based on whether the original IRA owner dies before or after his or her first beginning date for taking RMDs. If he or she died before, then the beneficiaries needn’t take distributions from the IRA each year. Instead, these beneficiaries can take annual distributions, they can wait until year 10 to take out all the money, or they can skip years, provided the IRA is fully depleted within 10 years. Tax and retirement professionals are fine with this provision. It’s the following that surprised them. If the deceased IRA owner died after the RMD start date, then annual RMDs must be paid to the beneficiary in years 1 through 9, with the rest of the account fully depleted by year 10. In this situation, the beneficiary would figure annual RMDs based on his or her life. So the younger the beneficiary, the smaller the RMD amounts. Of course, the beneficiary can take more than the RMD amount each year and can clean out the account before year 10 if he or she desires. 

The IRS’s proposal on the 10-year cleanout rule, which has not yet been finalized, has received lots of criticism. Practitioners want the 10-year rule to apply on a consistent basis, without regard to whether the IRA owner dies before or after the RMD beginning date.

Meanwhile, the IRS is giving relief. Last October the IRS said that beneficiaries of IRAs inherited after 2019, for which the deceased owner was already subject to RMDs, won’t be penalized for not taking distributions in 2021 or 2022. The IRS just extended that relief for such beneficiaries for 2023.

This first appeared in The Kiplinger Tax Letter. It helps you navigate the complex world of tax by keeping you up-to-date on new and pending changes in tax laws, providing tips to lower your business and personal taxes, and forecasting what the White House and Congress might do with taxes. Get a free issue of The Kiplinger Tax Letter or subscribe.