If you inherited an IRA from your spouse, you can choose to put the funds in your own IRA or into an inherited IRA. Each alternative has its own set of RMD regulations, so think about them carefully.
Option 1: Move the money into your own IRA
- Although you have not yet reached the age of 72*, your spouse has. It allows you to extend the tax-deferral benefits of your IRA assets by deferring distributions until you reach the age of 72.
- You are under the age of 591/2 and plan to take an IRA payout. In your IRA, you will be subject to a 10% early withdrawal penalty, but this penalty will not apply to an inherited IRA.
Option 2: Move the money into an inherited IRA
You withdraw RMDs based on your age if you put your money into an inherited IRA. RMD amounts are determined each year based on parameters in the IRS Single Life Expectancy Table and are depending on your age. Additionally, there is no 10-percentage-point withdrawal penalty, so it’s worth considering if you need cash right now.
Are RMDs required for inherited IRAs in 2020?
WASHINGTON, D.C. — Seniors and retirees should be aware that they are not forced to take money out of their IRAs or employment retirement plans this year, according to the Internal Revenue Service.
The Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, exempts IRAs and retirement plans from required minimum distributions in 2020, including beneficiaries of inherited assets. RMDs are covered under this waiver if you turned 70 1/2 in 2019 and took your first RMD in 2020. Withdrawals from a Roth IRA are not required until the owner passes away.
What is the RMD on an inherited IRA?
What is a Beneficiary/Inherited IRA or QRP Required Minimum Distribution (RMD)? The amount of money and/or assets that the recipient must withdraw each year by December 31 is known as an RMD.
Do I have to take an RMD in 2021 from my inherited IRA?
This year, don’t forget to take required minimum distributions from your retirement accounts. RMDs — the amounts you must take each year from most retirement accounts once you reach a particular age — were waived for 2020, but they are back in effect for 2021.
What are the new rules for inherited IRA distributions?
- When an IRA owner dies, the SECURE Act modified the criteria for dispersing funds from an inherited IRA.
- For non-spousal IRAs, the “stretch IRA” provision has been mostly eliminated. The new rule compels many beneficiaries to take all assets from an inherited IRA or 401(k) plan within 10 years following the death of the account holder for IRAs inherited from original owners who died on or after January 1, 2020.
- In some situations, disclaiming inherited IRA assets may make sense because they could boost the total value of your estate and push you over the estate tax exemption limit.
If you’re the son, daughter, brother, sister, or even a close friend of an IRA beneficiary, it’s vital that you—and the IRA owner—understand the regulations that govern IRA inheritances.
“With the enactment of the SECURE Act in December 2019, some of the procedures for inheriting and distributing assets upon the death of an IRA owner changed,” explains Ken Hevert, senior vice president of retirement products at Fidelity. “If IRA owners and beneficiaries aren’t diligent, they risk paying greater taxes or penalties, as well as losing out on future tax-advantaged growth.”
As a nonspouse beneficiary, here’s what you need to know about inheriting IRA funds. The criteria for inheriting IRA assets vary depending on your relationship with the IRA’s original owner and the sort of IRA you acquired. Whatever your circumstances, speaking with your attorney or tax counselor ahead of time may help you avoid unwanted repercussions.
Nonspouse inherited IRA owners are normally required to begin taking required minimum distributions (RMDs) no later than December 31 of the year after the death of the original account owner, according to the IRS.
With the passing of the SECURE Act, nonspouse IRA distributions must be completed within 10 years of the account owner’s death. You may previously “stretch” your dividends and tax payments out beyond your single life expectancy if you inherited an IRA or 401(k). For some recipients, the SECURE Act repealed the so-called “stretch” provision.
You don’t have the option of rolling the assets into your own IRA as a nonspouse beneficiary. You have numerous alternatives if you inherit IRA funds from someone other than your spouse:
Does an inherited IRA have to be distributed in 10 years?
The 10-year rule simply states that the inherited retirement account must be dispersed in full by the end of the tenth year after the death year.
What is the new 10-year rule for inherited IRA?
The following are the most relevant aspects of the “10-year” rule as it relates to the SECURE Act and inherited IRAs:
(1) Non-EDBs have ten years to complete their inherited IRA withdrawals; and
(2) During the 10-year period, non-EDBs are not subject to required minimum distributions (RMDs). In other words, they are not obligated to withdraw a certain amount each year during the course of the 10-year period. They can wait until the 10-year time is up and then withdraw the full inherited IRA account in one big sum.
In March 2021, the IRS released Publication 590-B for 2020, which included a section outlining the 10-year inherited IRA withdrawal rule. The IRS intimated in their explanation that RMDs would be required during the 10-year term, which was not the case.
Publication 590-B was recently updated by the IRS to clarify and rectify its position on the 10-year rule. The IRS specifically indicates that no RMDs are due if a non-inherited EDB’s IRA is fully withdrawn by the end of the 10-year anniversary of the original IRA owner’s death.
Harold, who owned a regular IRA, passed away on July 15, 2020. Vivian, Harold’s adult daughter, had been nominated as the sole beneficiary of his typical IRA. Vivian has until December 31, 2030, to withdraw her inherited IRA funds. Vivian has the option – but not the obligation – to withdraw any amount she wants before December 31, 2030.
The IRS further noted that, while EDBs are still eligible for lifetime distributions from their inherited IRAs based on their life expectancy (thus the term “stretch IRA”), they can choose to use the 10-year rule instead. This is only the case if the IRA owner passed away before the required start date. Individuals born before July 1, 1949, must begin on April 1 of the year in which they turn 70.5; those born after June 30, 1949, must begin on April 1 of the year in which they turn 72.
In some cases, an EDB may prefer the flexibility of the 10-year rule to being bound into a rigorous “stretch IRA” RMD plan each year, even if the time extends beyond the 10-year period.
Spouses get the most leeway
If a survivor inherits an IRA from their deceased spouse, they have numerous options for how to spend it:
- Roll the IRA over into another account, such as another IRA or a qualified employment plan, such as a 403(b) plan, as if it were your own.
Depending on your age, you may be compelled to take required minimum distributions if you are the lone beneficiary and regard the IRA as your own. However, in certain instances, you may be able to avoid making a withdrawal.
“When it comes to IRAs inherited from a spouse, Frank St. Onge, an enrolled agent with Total Financial Planning, LLC in the Detroit region, says, “If you were not interested in pulling money out at this time, you could let that money continue to grow in the IRA until you reach age 72.”
Furthermore, couples “are permitted to roll their IRA into a personal account. That brings everything back to normal. They can now choose their own successor beneficiary and manage the IRA as if it were their own, according to Carol Tully, CPA, principal at Wolf & Co. in Boston.
The IRS has more information on your options, including what you can do with a Roth IRA, which has different regulations than ordinary IRAs.
Choose when to take your money
If you’ve inherited an IRA, you’ll need to move quickly to prevent violating IRS regulations. You can roll over the inherited IRA into your own account if you’re the surviving spouse, but no one else will be able to do so. You’ll also have several more alternatives for receiving the funds.
If you’re the spouse of the original IRA owner, chronically ill or disabled, a minor kid, or not fewer than 10 years younger than the original owner, you have more alternatives as an inheritor. If you don’t fit into one of these groups, you must follow a different set of guidelines.
- The “stretch option,” which keeps the funds in the IRA for as long as feasible, allows you to take distributions over your life expectancy.
- You must liquidate the account within five years of the original owner’s death if you do not do so.
The stretch IRA is a tax-advantaged version of the pot of gold at the end of the rainbow. The opportunity to shield cash from taxation while they potentially increase for decades is hidden beneath layers of rules and red tape.
As part of the five-year rule, the beneficiary is compelled to take money out of the IRA over time in the second choice. Unless the IRA is a Roth, in which case taxes were paid before money was put into the account, this can add up to a colossal income tax burden for large IRAs.
Prior to 2020, these inherited IRA options were available to everyone. With the passage of the SECURE Act in late 2019, persons who are not in the first category (spouses and others) will be required to remove the whole balance of their IRA in 10 years and liquidate the account. Annual statutory minimum distributions apply to withdrawals.
When deciding how to take withdrawals, keep in mind the legal obligations while weighing the tax implications of withdrawals against the benefits of letting the money grow over time.
More information on mandatory minimum distributions can be found on the IRS website.
Be aware of year-of-death required distributions
Another challenge for conventional IRA recipients is determining if the benefactor took his or her required minimum distribution (RMD) in the year of death. If the original account owner hasn’t done so, the beneficiary is responsible for ensuring that the minimum is satisfied.
“Let’s imagine your father passes away on January 24 and leaves you his IRA. He probably hadn’t gotten around to distributing his money yet. If the original owner did not take it out, the recipient is responsible for doing so. If you don’t know about it or fail to do it, Choate warns you’ll face a penalty of 50% of the money not dispersed.
Not unexpectedly, if someone dies late in the year, this can be an issue. The deadline for taking the RMD for that year is the last day of the calendar year.
“If your father dies on Christmas Day and hasn’t taken out the distribution, you might not even realize you own the account until it’s too late to take out the distribution for that year,” she explains.
There is no year-of-death compulsory distribution if the deceased was not yet required to take distributions.
Take the tax break coming to you
Depending on the form of IRA, it may be taxable. You won’t have to pay taxes if you inherit a Roth IRA. With a regular IRA, however, any money you remove is taxed as ordinary income.
Inheritors of an IRA will receive an income tax deduction for the estate taxes paid on the account if the estate is subject to the estate tax. The taxable income produced by the deceased (but not collected by him or her) is referred to as “income derived from the estate of a deceased person.”
“It’s taxable income when you receive a payout from an IRA,” Choate explains. “However, because that person’s estate had to pay a federal estate tax, you can deduct the estate taxes paid on the IRA from your income taxes. You may have $1 million in earnings and a $350,000 deduction to offset that.”
“It doesn’t have to be you who paid the taxes; it simply has to be someone,” she explains.
The estate tax will apply to estates valued more than $12.06 million in 2022, up from $11.70 million in 2020.
Don’t ignore beneficiary forms
An estate plan can be ruined by an ambiguous, incomplete, or absent designated beneficiary form.
“When you inquire who their beneficiary is, they believe they already know. The form, however, hasn’t been completed or isn’t on file with the custodian. “This causes a slew of issues,” Tully explains.
If no chosen beneficiary form is completed and the account is transferred to the estate, the beneficiary will be subject to the five-year rule for account disbursements.
The form’s simplicity can be deceiving. Large sums of money can be directed with just a few bits of information.
Improperly drafted trusts can be bad news
A trust can be named as the principal beneficiary of an IRA. It’s also possible that something terrible will happen. A trust can unknowingly limit the alternatives available to beneficiaries if it is set up wrongly.
According to Tully, if the trust’s terms aren’t correctly crafted, certain custodians won’t be able to look through the trust to establish the qualified beneficiaries, triggering the IRA’s expedited distribution restrictions.
According to Choate, the trust should be drafted by a lawyer “who is familiar with the regulations for leaving IRAs to trusts.”
What is the difference between an inherited IRA and a beneficiary IRA?
An inherited IRA is one that you leave to someone after you pass away. The account must then be taken over by the beneficiary. The spouse of the deceased person is usually the beneficiary of an IRA, but this isn’t always the case. Although the inherited IRA laws for spouses and non-spouses are different, you can set up your IRA to go to a kid, parent, or other loved one. You can even direct your IRA to an estate, trust, or a beloved charity.
You have three options with your inherited IRA if you’re the surviving spouse. Rather than making it your own, you can simply identify yourself as the account owner, roll it over into another sort of retirement plan, or treat yourself as the beneficiary. You don’t have the choice to make the IRA your own if you’re a non-spouse inheriting the IRA. Either make a trustee-to-trustee transfer or withdraw the account. You’ll almost certainly have to withdraw the funds within five years of the original account owner’s death.
How long can you keep an inherited IRA?
The new law, which applies to IRAs inherited on or after Jan. 1, 2020, requires some heirs to drain funds within 10 years or face penalties on distributions “The ten-year rule.”
According to financial experts, these standards may impose a tax burden on higher earnings or those with significant balances.
“I’m not sure this has been around long enough for even estate-planning attorneys to fully comprehend the transition and its implications,” said Teresa Bailey, a certified financial planner with Waddell & Associates in Nashville, Tennessee.
However, there are techniques to lessen the impact of taxes. Here’s what you need to know about IRA accounts and beneficiaries.
What are RMD rules for 2021?
- If you were born before July 1, 1949, you must wait until April 1 of the year after the calendar year in which you turn 701/2.
- If you were born after June 30, 1949, you will turn 72 on April 1 of the year after the calendar year in which you turn 72.
Date that you turn 701/2 (72 if you reach the age of 70 1/2 after December 31, 2019)
On the 6th calendar month after your 70th birthday, you achieve the age of 701/2.
For example, you are 70 years old and celebrated your 70th birthday on June 30, 2018. On December 30, 2018, you became 70 1/2 years old. By April 1, 2019, you must have taken your first RMD (for 2018). Following that, you’ll take RMDs on December 31st of each year, as explained below.
For example, you are 70 years old and celebrated your 70th birthday on July 1, 2019. You are not obligated to take a minimum distribution until you reach the age of 72 if you turn 701/2 after December 31, 2019. On July 1, 2021, you turned 72 years old. Your first RMD (for 2021) must be taken by April 1, 2022, with additional RMDs due on December 31st each year following.
Terms of the plan govern
Even if you haven’t retired, a plan may mandate you to start collecting distributions by April 1 of the year following you become 701/2 (72 if born after June 30, 1949).
% owners
Even if you haven’t retired, if you hold more than 5% of the company that sponsors the plan, you must start collecting payments by April 1 of the year following the calendar year in which you reach age 701/2 (age 72 if born after June 30, 1949), even if you haven’t.
What is it?
The withdrawal of the whole value of an inherited traditional IRA or employer-sponsored retirement plan account in one tax year is known as a lump-sum distribution. A lump-sum payout is determined by this one-tax-year time frame, not by the amount of distributions. A lump-sum distribution can be made as a single payment or as a series of payments over the course of the tax year. When you inherit a traditional IRA, this distribution option is usually accessible, but it may also be available when you inherit a retirement plan account (if the terms of the plan allow it). If you are not the IRA or plan’s sole beneficiary, the lump-sum distribution choice will apply to your part of the inherited money separately.
You will be subject to federal (and probably state) income tax on a lump-sum payout as an IRA or retirement plan beneficiary for the tax year in which it is received (to the extent that the distribution represents pretax or tax-deductible contributions, and investment earnings). A lump-sum distribution is generally not viewed as the ideal option to disperse cash from an inherited IRA or plan for this and other reasons. Other options for taking post-death payouts will usually offer better tax treatment and other benefits.
Is there a way to avoid paying taxes on an inherited IRA?
After inheriting a retirement account, you have two basic alternatives. Withdraw the entire amount and face a hefty tax charge, or transfer the inherited 401(k) or IRA to a Beneficiary IRA (also known as an Inherited IRA) and delay taxes until withdrawals are made. If you wish to pursue the Inherited IRA route, there are a few rules to follow.
When it comes to cashing out an inherited retirement account, there are no age restrictions. The 10% early withdrawal penalty that would apply if you took money out of your personal retirement account before turning 59 1/2 years old does not apply. You will, however, be responsible for income taxes on the money you withdraw. If you withdraw all of the money from a larger IRA at once rather than over time, you may end up paying significantly more taxes.