By Tom Rasmussen, CFP®
Inheriting an IRA or Roth IRA can be overwhelming, and you may be unsure of what your options are. It is important to know what options are available for you as the beneficiary of an inherited IRA and what rules and laws exist.
Inherited IRA Options
Once you have inherited an IRA or Roth IRA, it is critical to consider what to do with the funds and how they should be handled. A few options are available for both spouse and non-spouse beneficiaries. They are listed below. The information in this article is most relevant to those who inherit IRAs after January 1, 2020.
- Treat the IRA as your own. As a spousal beneficiary, you can transfer the IRA into your own and treat it as if it were yours all along. The regular required minimum distribution (RMD) rules apply in this situation. RMDs must begin the year that you reach age 72 if you are not already taking them. RMDs are based on the Uniform Lifetime table, which can be found on IRS.gov. The 10% penalty still applies for withdrawals taken before age 59 ½.
- Transfer the IRA into an inherited IRA (which will be a completely new account in your name). The RMDs for an inherited IRA are based on the Single Life Expectancy table. If your spouse is older than 72 at the time of their passing, then RMDs in an inherited IRA must begin by December 31 of the year following their death. If they were younger than 72, you can delay RMDs until the year they would have turned 72.
- Lump-sum distribution (typically, not advised). As an IRA beneficiary, you can always take out the amount in a lump-sum distribution, but this is rarely advised as it will cause you unnecessary trouble and taxes.
- Transfer IRA to an inherited IRA. Non-spouse beneficiaries must open an inherited IRA by December 31 the year following the original account holder’s death. All assets must be withdrawn within 10 years. There is no RMD rule, as the distributions can be spread out however the beneficiary would like within the 10-year window. (The 10-year rule is detailed below.)
- Lump-sum distribution (typically, not advised). As a beneficiary, you can always take out the amount in a lump-sum distribution, but this is rarely advised as it will cause you unnecessary trouble and taxes.
Point to Consider
When choosing what to do with the inherited IRA, there are several factors that obviously need to be considered.
Although non-spouse beneficiaries do not have many options, spousal beneficiaries do. Whether you treat the IRA as your own or open an inherited IRA can depend on your immediate cash flow needs.
For example, if you have an immediate need to replace income, transferring the funds into an inherited IRA and beginning RMDs may be the right move for you. This is a discussion you will want to have with your financial planner.
The SECURE Act
The SECURE Act was passed and signed into law at the tail end of 2019. Although the new act offers incentives for small businesses, we will focus here on aspects of the act that may affect you.
- The age requirement for RMDs to begin was increased from age 70 ½ to age 72. Those who turned 70 ½ in 2019 are still required to withdraw their first RMD by April 1, 2020.
- The distributions from inherited retirement accounts can no longer be “stretched” over the lifetime of a non-spousal beneficiary. The SECURE Act requires that all assets be withdrawn within 10 years. There are no rules for minimum distributions within those 10 years, just that the entire balance must be distributed after the tenth year.
There are exceptions to the new 10-year withdrawal rule. For the following “eligible designated beneficiaries,” the 10-year rule does not apply, and they can continue to take distributions over their lifetime:
- Spousal beneficiaries (Single Life Expectancy table used)
- Disabled beneficiaries
- Chronically ill
- Non-spousal beneficiaries who are no more than 10 years younger than the decedent
- Minor children of the decedent (10-year rule begins once they reach the age of majority for their state)
It is great to inherit an IRA and leverage the opportunities those funds can provide for you and your family, but with the new laws in place, planning has become a little more difficult.
Previously, when non-spouse beneficiaries could stretch out the distributions over their lifetime, planning was much easier.
The issue that one may run into is that they inherit an IRA during their prime earning years and are required to withdraw the funds over the next 10 years, increasing their income and causing them to pay more in taxes.
This is an issue that many individuals are going to begin running into in the next few years. As an independent financial advisor, we understand this is a complex planning issue and one that you will want to discuss with your financial planner.
In conclusion, inheriting an IRA is wonderful, but some things need to be considered before taking any action. When considering what to do, your current tax situation and potential investment preferences need to be considered.
Schedule a complimentary meeting with a wealth advisor to discuss your personal situation.