IRS Notice 2024-35 Explained

In May of this year, our office released an article providing guidance related to IRS Notice 2024-35, which extended a waiver of any penalty for failure to take a Required Minimum Distribution* from an inherited IRA account through the 2024 tax year. At that time, there was uncertainty as to whether the much-anticipated final regulations from the IRS would, indeed, reinforce the requirement that beneficiaries of an IRA inherited in 2020 or later take annual RMDs, or instead eliminate the RMD requirement altogether. Let not your heart be troubled any longer, the wait is finally over! On July 19, 2024, the IRS put all questions to rest when it issued its final regulations, incorporating rules from both the SECURE Act and SECURE Act 2.0. In this article, we’ll break down the final regulations and help you better understand how to properly apply them.

*Required Minimum Distributions (RMDs) are the minimum amounts you must withdraw from your retirement accounts each year.

Background

First, a quick refresher on how we got here. You may remember from our May article that, prior to implementation of the SECURE Act, beneficiaries of an inherited IRA were subject the “stretch rule,” which allowed beneficiaries to use their life expectancy to stretch out inherited IRA distributions over their lifetime. The SECURE Act did away with the stretch rule, requiring instead that a Designated Beneficiary of an inherited IRA owned by someone who died in 2020 or later withdraw the entire balance by the end of the 10th year following year in which the original IRA owner died (now known as the “10-year rule”). The SECURE Act also provided that a Designated Beneficiary (defined further below) who inherits an IRA from someone who died after reaching their Required Beginning Date (or RBD, which is generally April 1 of the year after the year the IRA owner turns age 73) take annual RMDs from the account. As a result, a Designated Beneficiary of an inherited IRA subject to the final regulations, in addition to complying with the 10-year rule, must also ensure that they take an annual RMD until the balance is completely withdrawn. Because of confusion surrounding the RMD requirements under the new 10-year rule, the IRS issued successive waivers of any penalty for 2021, 2022, 2023, and 2024 if a Designated Beneficiary failed to take their annual RMD during those years.

How do I know if the final regulations apply to me?

The final regulations requiring annual RMDs for an inherited IRA apply if two criteria are met. First, the original IRA owner must have died after their RBD, meaning that if the original IRA owner died prior to their RBD, then the beneficiary need only comply with the 10-year rule without any requirement to take an annual RMD. Second, the beneficiary must be considered a Designated Beneficiary. Okay, so who is a Designated Beneficiary? A Designated Beneficiary is better defined by who it is not, rather than who it is. A Designated Beneficiary is any individual designated as a beneficiary of an IRA who does not qualify as an Eligible Designated Beneficiary (EDB). Take careful notice of the word “individual,” as trusts (other than “see-through trusts” with an identifiable individual beneficiary), estates, charities, and other legal entities are not individuals and may be subject to different rules which are beyond the scope of this article. The SECURE Act specifies that the following categories of individual beneficiaries qualify as an EDB:

1. Surviving spouses
2. Minor children of the Decedent (only until they reach age 21)
3. Chronically ill individuals
4. Disabled individuals (per strict IRS guidelines)
5. Individuals older than, or not more than 10 years younger than, the Decedent.

It’s critical to distinguish between a Designated Beneficiary and an Eligible Designated Beneficiary because an EDB may elect not to utilize the 10-year rule and can continue to take distributions over his or her single life expectancy or the deceased owner’s single life expectancy, whichever is longer. Even better, if the beneficiary is the surviving spouse of the deceased owner, then the surviving spouse also has the option to rollover the inherited IRA into their own IRA, treating those assets as if they were their own. 

To recap, if you are an individual beneficiary of an inherited IRA where the original owner died in 2020 or later and you do not fall into one of the EDB categories above, then you are a Designated Beneficiary subject to the 10-year rule. If you’re a Designated Beneficiary and the original IRA owner already reached his or her Required Beginning Date at the time of their death, then you are also subject to the annual RMD requirement. 

Although the scope of this article is limited to inherited IRA accounts, the final RMD regulations also apply to other inherited Employer Plans, such as a 401(k), 403(b), or eligible government 457(b) plan. It’s also important to remember that the RMD requirement only applies to a Designated Beneficiary of a traditional IRA account. Beneficiaries of a Roth IRA account inherited in 2020 or later, although still subject to the 10-year rule, do not have any obligation to take annual RMDs and can instead take tax-free distributions at their discretion, so long as the entire account is withdrawn within the 10-year period.

The final regulations apply to my inherited IRA. How do I calculate my annual RMD?

Now that you know whether the final regulations apply to your inherited IRA, how do you figure the amount of your annual RMD? The beneficiary must start by finding their baseline life expectancy provided in the Single Life Expectancy (Table I) published by the IRS. The baseline life expectancy is determined by taking the age of the beneficiary in the year after the year in which the original account owner died and finding the corresponding life expectancy shown in the table. Using the excerpt from the Single Life Expectancy table below, you can see that if the original owner died in 2021 and the beneficiary turned 60 in 2022, then the beneficiary’s baseline life expectancy would be 27.1.

 The beneficiary would then take the value of the inherited IRA on 12/31 of the year in which the original owner died and divide it by the baseline life expectancy, resulting in the annual RMD amount for the first year of the 10-year period. For each year thereafter, the beneficiary would then subtract 1.0 from the baseline life expectancy for each subsequent year after the year in which the baseline life expectancy was established.

For purposes of demonstration, let’s assume that Isaac is the beneficiary of an IRA that was owned by his father, Abe, who died in 2022 at age 82. Based on that information alone, we already know that Isaac is:

1. a Designated Beneficiary—because he doesn’t fall into one of the EBD categories;
2. subject to the 10-year rule—because the year Abe died was 2020 or later; and
3. subject to the annual RMD requirement—because Abe had already reached his RBD at the time of his death.

Isaac will be required to withdraw the entire balance out of the inherited IRA by 12/31/2033, which is the end of the 10th year beginning in 2023, the year after Abe died. Let’s also assume that Isaac turned age 57 in 2022, the year Abe died, meaning that Isaac turned 58 in 2023, the first year in which Isaac must take an annual RMD. Looking at the Single Life Expectancy Table, the baseline life expectancy for a person 58 years of age is 28.9. Finally, assume that the total market value of the inherited IRA account was $300,000 as of 12/31/2022. $300,000 / 28.9 = $10,380.62, which is the total amount of Isaac’s 2023 RMD. For 2024, Isaac would then take the 12/31/23 value of the inherited IRA and divide it by 27.9, which is his baseline life expectancy of 28.9 less 1.0 because it’s now one year after his baseline life expectancy was established in 2023.

Does the RMD calculation change if I took advantage of the waiver?

But wait…what about that waiver you mentioned? Let’s assume that Isaac took advantage of the RMD waiver for 2023 and 2024, so he had no penalty for failing to take an RMD in those two years. It’s now 2025—the third year of his 10-year period—and he must take an annual RMD or he will face a penalty. Additionally, assume that the IRA account grew in value since Abe died and had a total value of $325,000 on 12/31/24. The method to calculate Isaac’s 2025 RMD won’t change at all. Isaac will take the 12/31/24 value of $325,000 and divide it by 26.9, which is his baseline life expectancy of 28.9 less 1.0 for each of the two years after his baseline expectancy was established in 2023. $325,000 / 26.9 = $12,081.78, which is the total amount of Isaac’s 2025 RMD.

One very important point based on the last scenario: pursuant to the 10-year rule, Isaac must still have the entire account balance withdrawn by 12/31/2033—the end of the 10th year beginning in 2023, the year after Abe died—even though he chose to rely on the penalty waiver for the first two years. In other words, the 10-year rule remains in effect regardless of whether a beneficiary took advantage of the RMD penalty waiver in the years 2021 through 2024. 

Confused yet?

If you made it to this point, your head might be spinning. We get it… how can you be expected to keep up with all these rules and calculate your RMD each year? Good news! First Financial Trust customers who are beneficiaries of an inherited IRA can rest easy and remain confident in our ability to parse through all the regulations, calculate and notify them of their total annual RMD each year, distribute the RMD funds to them, and even hold back funds to cover federal taxes owed on the distribution. If you’re not a First Financial Trust customer yet, give us a call and let us help guide you in the right direction. Ultimately, the most important thing is that any beneficiary of an inherited IRA consult with their tax and financial advisors to develop and implement a strategy that complies with the final regulations based on their specific circumstances.