In a recent interview with NBC, certified financial planner Ben Smith from Cove Financial Planning discussed the complexities surrounding the inheritance of Individual Retirement Accounts (IRAs), especially in light of the SECURE Act of 2019. This legislation introduced new tax obligations for inherited IRAs, requiring beneficiaries to withdraw the full balance within ten years unless they meet specific exceptions. Not meeting these withdrawal requirements could lead to mandatory distributions by the IRS after the ten-year period, potentially resulting in a significant increase in taxable income and the loss of various tax benefits.
Smith pointed out that high-income earners need to be particularly vigilant about the new rules affecting their inherited IRAs. A sudden large distribution could substantially elevate their income, pushing them into a higher tax bracket and costing them valuable tax credits. He shared an example of a client who experienced a drastic rise in annual income due to a one-time IRA withdrawal, which not only triggered a hefty tax bill but also disqualified this client from receiving a $7,500 tax credit for purchasing an electric vehicle.
As of 2020, heirs of account holders who were eligible for withdrawals at the time of death still must empty the account within ten years. This marks a significant shift from previous regulations that permitted beneficiaries to withdraw funds over their lifetimes as part of their own IRAs. The IRS has provided a grace period, but as of July 2024, compliance with the ten-year withdrawal requirement will be enforced, and failure to comply could lead to compulsory distributions.
The intention behind these changes is to encourage the flow of IRA funds, which is also expected to yield considerable tax revenue for the IRS. Beneficiaries who are unaware of their new obligations may face serious financial repercussions.
The tax implications for IRAs depend on the age of the account holder at the time of death and the status of the beneficiary. The “required beginning date,” the age at which account holders must start taking distributions, was updated to 73 in 2023 and will increase to 75 by 2033.
Certain beneficiaries, such as spouses, minor children, disabled individuals, and those who are chronically ill, as well as beneficiaries of specific trust funds, may still benefit from the old rules, allowing for lifetime withdrawals without the ten-year limit.
Carl Holubowich, another certified financial planner from Armstrong, Fleming & Moore, advised that instead of waiting for the IRS to impose taxes, beneficiaries should proactively consider their withdrawal strategies, particularly in lower-income years. This could help lessen the tax burden by permitting gradual withdrawals rather than a forced lump sum at the end of the period.
For the 2025 tax year, federal tax brackets begin at 10% for incomes up to $11,000, scaling up to 39.6% for the highest earners. This structure impacts how beneficiaries should approach their IRA withdrawals to manage tax liabilities effectively.
