The IRS has officially ended any remaining hope of revising its new guidelines for inherited individual retirement accounts (IRAs), effectively closing the door on the "stretch" strategy for most beneficiaries. Under the final rules issued last month, non-eligible beneficiaries who inherited IRAs in 2020 or later must transfer all assets into their income within a decade. This announcement means beneficiaries need to start taking required minimum distributions (RMDs) next year if they haven't already.

Heather Zack, director of high net worth solutions at Commonwealth Financial Network, noted that the rules align with a strategy most advisors had already adopted: spreading distributions over 10 years to avoid a large tax bill in a single year. Few advisors were recommending that clients wait until the 10th year to withdraw everything.

Matthew Cleary, a financial planner with Sentinel Group, emphasized the importance of discussing these rules with clients who inherited IRAs in the past four years. He advises creating a withdrawal schedule to minimize the tax burden, given that the stretch IRA strategy is effectively dead.

Exceptions to the 10-year rule exist for eligible designated beneficiaries, including the spouse of the deceased, heirs who are chronically ill or disabled, and those who are no more than 10 years younger than the original IRA owner. Heirs under 21 years old can still use the stretch strategy until they turn 21, after which the 10-year window begins.

The rules also maintained the controversial provision that requires beneficiaries to continue RMDs if the original account owner had already started them before passing away. Despite some industry hopes that this requirement would be removed, the IRS has doubled down, stating that RMDs must resume by 2025. However, the IRS will not impose penalties for missed RMDs for the years 2021-2024.

The IRS addressed concerns about this interpretation in its July 18 press release, explaining that they decided to keep the rule requiring ongoing annual payments if the account balance is fully distributed within the 10-year period after the original owner’s death.

Jeffrey Levine, Chief Planning Officer at Buckingham Strategic Wealth, highlighted this decision as the top question advisors have been asking for over two years. He acknowledged that while the industry had eagerly awaited these guidelines, the IRS has now provided definitive answers. Converting traditional IRAs to Roth IRAs could be a viable strategy for IRA owners looking to reduce the tax burden on their beneficiaries. While Roth IRAs are still subject to the 10-year rule, they don’t carry the same tax implications.

Zack pointed out that while there aren’t many strategies to lessen the impact of the new distribution rules, charitable donations and maximizing other deductions could help mitigate the tax burden. The rules have added complexity to managing inherited IRAs, creating a maze of withdrawal requirements based on various factors like the year of death and the heir’s status. In summary, the IRS's final rule has complicated the landscape for inherited IRAs, emphasizing the need for careful planning and ongoing consultation with financial advisors to navigate these changes.

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