Inheriting an IRA Account
Inheriting assets can evoke a range of emotions; from the sorrow of losing a loved one to the joy of remembering their legacy. It can also bring frustration in administering an inherited IRA (Individual Retirement Account). With the various segments of the recently passed SECURE Act (Setting Every Community Up for Retirement Enhancement), introduced in the past few years, administering an inherited IRA has become complex. Abiding by the many new rules and regulations is essential to avoid tax issues and penalties. The rules depend on several factors, including the type of IRA and the relationship to the original account holder. Here’s a simple guide to help navigate the basics.
The SECURE Act brought significant changes to inherited IRAs. Before the act passed at the end of 2019, the life of inherited IRAs could stretch by taking Required Minimum Distributions (RMD) over the beneficiary’s life expectancy, even for a non-spouse beneficiary. Since withdrawals from an IRA are taxable as ordinary income, stretching the life of the IRA provided a significant degree of flexibility. With the most recent updates to the SECURE Act, RMDs will depend on whether the beneficiary is a spouse or non-spouse beneficiary and whether the decedent started RMDs before passing.
Most rules have remained the same for the spouse of the original account holder. The surviving spouse can roll the inherited IRA into their existing IRA, which provides the most control. As mentioned, significant changes to inherited IRA rules occurred for non-spouse beneficiaries when the decedent already started RMDs. In this case, a non-spouse beneficiary must generally follow the 10-year rule, which requires the beneficiary to distribute the entire balance by year ten. The beneficiary must take annual distributions during the ten years, starting after the year of the decedent’s passing. Due to the confusion of the legislation, the IRS did not require yearly distributions during the years 2021 through 2024, though the 10-year rule remains in force.
Certain beneficiaries, such as minor children, disabled individuals, or chronically ill persons, may qualify for exceptions to the 10-year rule as the IRS deems these individuals Eligible Designated Beneficiaries. In this case, the stretch rules could apply, and withdrawals could occur over the beneficiary’s life expectancy, offering more flexibility and reducing the immediate tax burden.
Withdrawals from a traditional IRA are taxed as ordinary income. In contrast, withdrawals are tax-free with an inherited Roth IRA as long as the decedent’s Roth IRA was open for at least five years prior. Planning to minimize the tax impact of large distributions from an inherited traditional IRA is essential. A large distribution at the end of year ten, when the entire account balance must be fully distributed, could result in substantial taxable income.
Whether you are a spouse or a non-spouse beneficiary of an inherited IRA or know you will soon inherit one, contact your Heritage Wealth Architects team. Your team will guide you through the paperwork and complex rules and incorporate the inheritance into your financial plan in a way that makes the most sense for your individualized tax and cash flow situation.
More Information: IRS Guidelines | www.irs.gov/
Michael Kitces | www.kitces.com/blog/secure-act-2-0-irs-regulations