Before 2020, anyone who became an IRA beneficiary before that date was normally entitled to take RMDs from the inherited IRA based on their life expectancy. Anyone in such situation can keep taking their RMDs as they were before the SECURE Act was passed. Of course, a pre-2020 IRA recipient can take a distribution that is greater than the RMD at any time.
No one has been named as a beneficiary. It’s critical that an IRA’s beneficiaries be one or more individuals, and only individuals. An IRA must have a chosen beneficiary to maximize tax deferral, and only persons can be designated beneficiaries, according to the regulations.
When no beneficiary is named or when the estate or trust (with some exclusions) is identified, an IRA does not have a designated beneficiary. A chosen beneficiary is not a charity, business, or other legal organization.
The restrictions that apply when an IRA doesn’t have a specified beneficiary were not changed by the SECURE Act.
The necessary distribution schedule for these IRAs is determined by whether the IRA owner died before or after the mandatory beginning date for RMDs. The required starting date for people who turned 701/2 in 2020 or later is age 72. Age 701/2 is the required start date for everyone else.
The five-year rule applies if the IRA owner died before the statutory start date. Within five years, the full IRA must be distributed. When an IRA owner dies after the statutory start date, the IRA can be distributed as if the owner were still alive, using the IRS’s life expectancy tables to determine the owner’s remaining single life expectancy. Obviously, the IRA can be distributed more quickly than is required.
Beneficiary is the surviving spouse. The 10-year rule does not apply to surviving spouses who are IRA beneficiaries. Survivors’ options are the same as they were prior to the SECURE Act.
A surviving spouse’s option is to roll the IRA over to an IRA in the surviving spouse’s name. A new IRA or an existing IRA can be used. This is referred to as a “new start” IRA because the surviving spouse can treat the IRA as if it had always been his or hers, with no reference to the deceased spouse’s IRA.
In a fresh start IRA, the surviving spouse pays RMDs based on his or her age and specifies beneficiaries for the IRA without referring to the IRA of the deceased spouse.
The surviving spouse can also treat the IRA as though it were an ordinary inherited IRA. The distinction is that the surviving spouse is no longer bound by the 10-year requirement after the SECURE Act. The surviving spouse of an inherited IRA follows the old regulations, which allow for a Stretch IRA with RMDs taken over the life expectancy of the surviving spouse.
Beneficiaries who are eligible. The eligible designated beneficiary is a new type of beneficiary created under the SECURE Act (EDB). A beneficiary who is exempt from the 10-year rule is known as an EDB. An EDB is a surviving spouse.
A beneficiary who is not more than 10 years younger than the deceased IRA owner, a minor child of the deceased IRA owner, a crippled or chronically ill beneficiary, and a beneficiary who is not more than 10 years younger than the deceased IRA owner are all EDBs.
A grandchild is not an EDB, although a minor child is. Furthermore, a minor child is only an EDB while he or she is under the age of majority in their state (18 in most states). The 10-year clock starts ticking once the beneficiary achieves the age of majority.
After 2019, IRA estate planning took on a whole new meaning. You want to make certain that you name the correct beneficiaries and that they receive sound counsel. You could also want to think about using one of the ways that effectively allows you to dodge the new rules while still getting similar, if not better, outcomes than the previous Stretch IRA.
What happens when you inherit an IRA from a parent?
Many people believe that they can roll over an inherited IRA into their own. You cannot roll an IRA into your own IRA or treat it as your own if you inherit one from a parent, aunt, uncle, sibling, or acquaintance. Instead, you’ll have to put your share of the assets into a new IRA that’s been established up and properly labeled as an inherited IRA for example, (name of dead owner) for the benefit of (name of deceased owner) (your name).
If your mother’s IRA account has more than one beneficiary, money can be divided into separate accounts for each. When you split an account, each beneficiary can treat their inherited half as if they were the only one.
An inherited IRA can be set up with almost any bank or brokerage firm. The simplest choice, though, is to open your inherited IRA with the same business that handled your mother’s account.
Most (but not all) IRA beneficiaries must drain an inherited IRA within 10 years of the account owner’s death, thanks to the Secure Act, which was signed into law in December 2019. If the owner died after December 31, 2019, this rule applies to inherited IRAs.
What are the new rules for an inherited IRA?
When you inherit another person’s retirement account, whether it’s an individual retirement account or an employer-sponsored plan like a 401(k), you set up an inherited IRA, also known as a beneficiary IRA (k). The rules for inherited IRAs are determined by two major factors:
- Whether your spouse was the initial owner: You don’t need to set up an inherited IRA if you inherit your spouse’s retirement account. You might also choose to transfer the funds to your own retirement account. If you opt for a rollover, the funds will be regarded as if they were your own retirement assets from the start. If you’re not married, however, you don’t have this option. You must set up an inherited IRA unless you take the money in a lump sum or disclaim it.
- When the account owner died: On or after Jan. 1, 2020, IRAs inherited from someone who died on or after that date will be subject to new SECURE Act restrictions. If the account owner dies on or after January 1, 2020, the new law eliminated the “stretch” provisions for most inherited IRAs.
What is the difference between a traditional IRA and an inherited IRA?
When an individual inherits an IRA or an employer-sponsored retirement plan after the original owner dies, an inherited IRA is created. The beneficiary of an Individual Retirement Account (IRA) might be anyonea spouse, a relative, or an unconnected party or corporation (estate or trust). However, the rules for handling an inherited IRA differ for spouses and non-spouses.
A beneficiary IRA is also known as an inherited IRA. Many of the top IRA brokers can assist you in resolving difficulties such as IRA asset inheritance, taxation, and the continuation of your retirement account status.
The Setting Every Community Up For Retirement Enhancement (SECURE) Act of 2019, which made some important modifications to the regulationsprimarily for heirs other than spousesmade the tax laws regarding inherited IRAs considerably more convoluted.
What is the 5 year rule for inherited IRA?
The method of distribution will be determined by the date of death of the original IRA owner and the kind of beneficiary. If the IRA owner’s RMD obligation was not met in the year of his or her death, you must take an RMD for that year.
For an inherited IRA from a decedent who died after December 31, 2019, the following rules apply:
In most cases, a designated beneficiary must liquidate the account by the end of the tenth year after the IRA owner’s death (this is known as the 10-year rule). During the 10-year period, the beneficiary is free to take any amount of money at any time. There are some exclusions for certain qualifying designated beneficiaries, who are described by the IRS as:
*A minor kid becomes subject to the 10-year rule once they attain the age of majority.
An eligible designated beneficiary can choose between the 10-year rule and the lifetime distribution rules that were in force prior to 2020 and are detailed in the section below titled “For an inherited IRA received from a decedent who died before January 1, 2020.”
Vanguard’s RMD Service does not support accounts that are being distributed based on the 10-year rule. If you’ve chosen to apply the 10-year rule for your inherited account or are forced to do so, you should consult your tax advisor if you have any issues regarding how to take distributions under this rule. If the account owner died before he or she was required to begin taking RMDs, a non-designated beneficiary (e.g., an estate or charity) would normally be subject to the 5-year rule (April 1st of the year following the year in which the owner reached RMD age). The non-designated beneficiary would be subject to an RMD based on the original IRA owner’s life expectancy factor if the IRA owner died on or after April 1st of the year following the year in which the owner achieved RMD age. Certain forms of trusts are subject to certain requirements.
For an inherited IRA from a decedent who died before January 1, 2020, the following rules apply:
When a beneficiary inherits an IRA from an account owner who died before the account owner was required to begin taking RMDs (April 1st of the year following the owner’s RMD age), the recipient has two options for distribution: over his or her lifetime or within five years (the “five-year rule”).
The major beneficiary is the spouse. If the owner’s spouse chooses to be a beneficiary of the IRA rather than assume the account, he or she can decide when to start taking RMDs based on his or her own life expectancy. By the later of December 31 of the year after the owner’s death or December 31 of the year the owner would have attained RMD age, the spouse must begin taking RMDs. The spouse beneficiary should wait until the year before he or she plans to start taking RMDs to enroll in our RMD Service. If the owner’s spouse decides to inherit the IRA, he or she must begin taking RMDs by December 31 of the year following the owner’s death or April 1 of the year after the spouse’s RMD age.
When a non-spouse is the major beneficiary, and when the spouse is not the sole beneficiary. By December 31 of the year following the owner’s death, an individual non-spouse beneficiary must begin taking RMDs based on his or her own life expectancy. If all of the beneficiaries have created separate accounts by December 31 of the year after the owner’s death and started in that year, they can take RMDs based on their respective life expectancies. If all numerous beneficiaries have not opened separate accounts by December 31, all beneficiaries must begin taking RMDs in the year after the owner’s death, based on the oldest beneficiary’s life expectancy.
Any individual recipient has the option of distributing the inherited IRA assets over the next five years after the owner passes away. The distribution must be completed by the end of the year in which the owner’s death occurs for the fifth time. If the owner died before taking RMDs, any non-individual beneficiary (excluding a qualifying trust) must use the five-year rule.
Vanguard’s RMD Service does not support accounts being allocated in accordance with the five-year rule. If you’ve chosen to apply the five-year rule for your inherited account or are forced to do so, you should see your tax advisor if you have any issues regarding how to take distributions under this rule.
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.
How do I avoid paying taxes on an inherited IRA?
With a so-called Roth IRA conversion, IRA owners can transfer their balance from pre-tax to after-tax, paying taxes on both contributions and earnings. “If they’re in a lower tax bracket than their beneficiaries, it would probably make sense,” Schwartz said.
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 categories, 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 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.
What is the 10-year rule for inherited IRA?
“According to the 10-year rule, IRA beneficiaries who are not receiving life expectancy payments must withdraw the whole balance of the IRA by December 31 of the year after the owner’s death.”
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.
How much tax do you pay on an inherited IRA?
If you are the beneficiary of a stretch IRA, you must take your first required minimum distribution by December 31 of the year after the death of the IRA owner. To determine the needed minimum distribution amount, you’ll need the following information:
- Your age on December 31st of the year following the death of the original IRA owner; and
Can you reinvest an inherited IRA?
If you already have an IRA, you can transfer the inherited funds to another traditional IRA or convert them to a Roth IRA. A direct trustee-to-trustee transfer from one account to another, or between one IRA custodian and another, is the simplest way to do so.