Best advice? Ignore the 10-year RMD rule

The IRS has released almost 300 pages of regulations on required minimum distributions (RMDs) for IRAs and 401(k)s, in two parts. The first part was the FINAL Secure Act Regulations-7-18-24.pdf which ran 260 pages. The second part was the Proposed SECURE 2.0 Regualtions-7-18-24.pdf which ran another 36 pages.

The 10-year RMD rule stays

The main item advisors wanted to know about was whether the IRS would keep its controversial 10-year rule requiring annual RMDs for so-called “non-eligible designated beneficiaries” of account owners who died after starting RMDs. These include most non-spouse beneficiaries.

The IRS stuck to its guns, based on its interpretation of the SECURE Act. The IRS stance is not surprising, since the IRS told us this when it issued the proposed RMD regulations back in February 2022. There was so much confusion when those proposed rules came out that the IRS waived annual RMDs for the past four years (2021-2024). But now these RMDs must be taken beginning in 2025. The waived RMDs do not have to be made up, and there will be no penalty for failing to take them.

Besides taking annual RMDs, affected beneficiaries must fully withdraw any balance remaining in year 10 by the end of that year. 

Years 1-9 RMDs are based on the old stretch IRA rules. Under those rules, beneficiaries will calculate these RMDs based on their own age in the year after death. Even though beneficiaries who inherited in 2020 or later did not have to take annual RMDs (since they were waived), they must calculate their 2025 RMD by going back to the year after death and looking up the life expectancy factor from the Single Life Table that corresponds to the age they turned that year. That is their starting point, and that factor is reduced by 1 for each succeeding year.

Example: In 2020, Joe (age 50) inherits a $250,000 IRA from his mother, age 80, who had already been taking RMDs. Joe is subject to the 10-year rule, and since his mother died after beginning RMDs, Joe would normally have had to take annual RMDs for years 1-9 of the 10-year term beginning in 2021 (the year after death). But the IRS waived the 2021, 2022, 2023 and 2024 RMDs, so Joe was not required to take any of these.

In 2025, Joe must begin taking his RMDs. To calculate his 2025 RMD, Joe looks up the life expectancy for age 51 (his age in the year after death) from the Single Life Table in IRS Publication 590-B. That factor is 35.3 years.

Joe then reduces that factor by 1 for each year for 2022, 2023, 2024, and 2025 (4 years), producing a 2025 RMD factor of 31.3 (35.3 – 4.0 = 31.3). Joe will divide the balance in his inherited IRA on December 31, 2024 (which has now grown to $300,000) by 31.3, so his 2025 RMD is $9,585 ($300,000 / 31.3 = $9,585). Joe still must empty the inherited IRA account by the end of the 10^th year after death (December 31, 2030), even though he did not have to start taking RMDs until 2025.

Following RMD rules = bad tax planning

Now that you know the rules – Ignore them!

Instead, do better long-term tax planning, not only for affected beneficiaries, but also for IRA owners who can still make changes to reduce the overall tax bill both for themselves and their beneficiaries.

Here’s why:

Joe, in our example above, thinks he got a break by not having to take RMDs for the last 4 years. Joe may be thinking he saved taxes each of those years. But Joe didn’t “save” taxes; he increased them.

Joe now has only 6 years (2025-2030) to withdraw the entire inherited IRA balance. Joe may even make this situation worse by taking only the RMD amount for the next 5 years (2025-2029). That would leave him a hefty tax bill for 2030 (the 10^th year after death), when the entire remaining balance must be taken. Pushing all that income into one year will more than wipe out all the taxes Joe thought he saved by taking only what was required in years 1-9.

Joe likely left low tax brackets unused for the first 4 years because RMDs were waived. That will also be true for the next 5 years if Joe only takes the RMD.

The better tax planning strategy

The key to all good tax planning is to always pay taxes at the lowest rates, taking maximum advantage of low tax brackets every year. If lower 22% and 24% brackets are wasted, they are lost forever. You don’t get credit in future years.

The problem for many retirement savers is the RMD mentality, or more precisely the “minimum” mentality, which leads most to take only the amount required each year. But the “M’ in RMD stands for “minimum,” not “maximum.”

IRA owners should even be withdrawing from their IRAs before they are required to at age 73. Convert enough of the IRA funds to Roth IRAs to use up all of the low brackets. IRA beneficiaries cannot do this since inherited IRAs cannot be converted to inherited Roth IRAs. But IRA owners can and should, so that beneficiaries don’t get stuck with a big tax bill under the 10-year rule. Because of that rule, more funds will have to be withdrawn in a shorter window, which will almost always result in a larger tax bill.

Beneficiaries subject to the 10-year rule should not be taking only minimum distributions but should be increasing them to take maximum advantage of the low tax brackets. Taking more each year and spreading the income over the 10 years will smooth out the income, resulting in a lower overall tax in most cases.

The best IRA tax planning: Ignore RMDs and think “maximum” – NOT  “minimum.”

For more information on Ed Slott and Ed Slott’s 2-Day IRA Workshop,please visit www.IRAhelp.com