Have you inherited an IRA? Confused about the rules? You’re not alone.
The SECURE Act passed in 2019 changed the guidelines for inherited IRAs. This article will cover these new rules applying to account holders who have died on or after January 1, 2020.
(If you have inherited an IRA from someone who passed prior to January 1, 2020, please consult with your financial advisor to learn your options.)
If you recently inherited an IRA, you have a few options to take:
- Lump sum distribution
- Spousal transfer
- Life expectancy payments
- 10-year rule
We’ll cover each below.
Lump Sum Distribution
Whether you are a spouse or non-spouse designated beneficiary, you have the option to take a lump sum distribution of the IRA funds. You will pay income taxes on this distribution. If going this route, keep in mind a lump sum distribution could potentially push you into a higher tax bracket for the year.
Spousal Transfer
As a surviving spouse, you have the option to be treated as the IRA owner if both apply:
- You are the sole beneficiary of the IRA
- Your spouse died before the beginning date of taking required minimum deductions (RMDs)
Traditional and Roth IRA withdrawal rules then apply as if all funds are your own.
Life Expectancy Payments
In this method, if you are an eligible designated beneficiary and the IRA owner died after the required beginning date for taking RMDs, you are required to take annual life expectancy payments, as estimated by the IRS Single Life Expectancy table OR based on the owner’s life expectancy — whichever is longest. These distributions are taxed as income.
Who is considered an eligible designated beneficiary?
- Surviving spouse
- Owner’s minor child
- A disabled individual
- Chronically ill individual
- Any individual who is not more than 10 years younger than original IRA owner
If the original IRA owner had NOT started taking RMDs when you inherited the IRA, this type of payout method is optional. You may also choose the 10-year method.
The 10-Year Rule
If the owner of the IRA died before being required to take RMDs, as an eligible designated beneficiary, you are free to elect to take life expectancy payments or choose the 10-year rule.
What’s the 10-year rule, exactly?
Passed within the SECURE Act, the IRS describes the 10-year rule like this:
“The 10-year rule requires the IRA beneficiaries who are not taking life expectancy payments to withdraw the entire balance of the IRA by December 31 of the year containing the 10th anniversary of the owner’s death. For example, if the owner died in 2023, the beneficiary would have to fully distribute the IRA by December 31, 2033.”
However, the IRS notes that if you are NOT considered an “eligible” beneficiary, you are required to adhere to the 10-year rule. (See section above for who qualifies as an eligible beneficiary.)
All distributions are taxed as regular income. The 10% early withdrawal fee does not apply in this instance.
Rules for Minors Who Inherit IRAs
If the designated beneficiary is a minor under the age of 21, the inherited IRA rules are a bit different. A minor can take annual life expectancy payments.
However, once the minor reaches age 21, life expectancy payments can no longer be made, and the 10-year rule kicks in. For example, if the designated beneficiary turns 21 in 2023, they must withdraw all funds no later than December 31, 2033.
Talk to a financial advisor to learn the rules of an inherited IRA
It’s already an emotionally-charged time when it comes to losing a loved one. Managing finances and learning the rules of inherited IRAs are likely the last thing you’re wanting to do. But we want to help you clearly understand your options while being sensitive to your loss. Get in touch with a Landmark financial advisor to help you decide the best next step for your inherited IRA.
This material was created by Starling Digital for use by Landmark Financial, LLC and does not represent the views and opinions of Avantax Wealth Management or its subsidiaries.