Spouses, parents, and grandparents often want to leave a financial legacy for their loved ones after they are gone. This can take several forms, such as leaving real estate, a business, or assets in a retirement account to a family member or friend. An inherited IRA is another option.
When someone dies, they may leave an IRA to a spouse, a family member, or another individual they choose. However, the rules for when to take a required minimum distribution (RMD), which is the minimum amount you need to withdraw from an inherited IRA each year, are different for spousal and non-spousal beneficiaries. Recent changes to federal law also affect how you can handle the money in this account. Here is what to consider.
Changes That May Affect Your Inherited IRA
The SECURE Act, which stands for Setting Every Community Up for Retirement Enhancement, took effect on January 1, 2020.1 It introduced several changes for inherited IRAs.
10-Year Withdrawal Rule
If an IRA account holder dies on or after January 1, 2020, most beneficiaries must withdraw all funds within 10 years of the account holder’s death. If the account is not emptied within 10 years, a 50% penalty may apply to the remaining balance.
Exceptions to the 10-Year Rule
The 10-year rule does not apply to certain beneficiaries:
- Spouses
- Minor children (a different rule applies once they reach the age of majority)
- Individuals who are disabled or chronically ill
- Beneficiaries within 10 years of the original account holder’s age
How Rules Changed
| Before the SECURE Act | After the SECURE Act |
|---|---|
| Non-exempt beneficiaries could withdraw funds within five years or take RMDs over time | Most non-exempt beneficiaries must withdraw all funds within 10 years |
| Younger beneficiaries could stretch distributions over decades | Long-term “stretch” option is generally no longer available |
Under the previous rules, spreading withdrawals over time allowed the remaining balance to continue growing tax-deferred. Under the current law, faster withdrawals may result in higher taxes if distributions are taken during higher-income years.
Considerations When Navigating Changes to Inherited IRAs
If you plan to pass on an IRA or expect to inherit one, these points can help simplify decisions.
If the Money Is in a Trust
An inherited IRA may be held in a trust. This can limit access, especially for younger beneficiaries who may face age restrictions or annual withdrawal limits.
If a trust is listed as the beneficiary, you may want to adjust your approach:
- Distribute funds evenly over 10 years: Helps avoid a large, one-time tax bill.
- Use a different trust structure: Accumulation or discretionary trusts may allow more control over distributions.
Keep in mind, these options can have tax implications. A qualified estate planning attorney can help review your situation.
Spreading Out Distributions
Under the 10-year rule, most non-spousal beneficiaries are not required to take annual RMDs. However, the full balance must be withdrawn within 10 years. You may consider different withdrawal strategies:
| Strategy | How It Works | Potential Benefit |
|---|---|---|
| Equal Distributions | Withdraw the same amount each year | Helps manage taxes over time |
| Variable Distributions | Take more in lower-income years | May reduce total taxes owed |
The right approach depends on your income and tax bracket. A tax professional can help guide this decision.
Annuities
Another option is to convert the assets in the IRA into an annuity. An annuity can help defer taxes, provide growth potential, and set up an income stream that aligns with the 10-year rule.
If you are the original IRA account holder and have already converted your IRA into an annuity, you can pass it on to your beneficiaries. If you have started receiving payments, the insurance company may provide your beneficiaries with a refund of any unpaid premium after your death, depending on the policy.
Roth Conversions
If you have a traditional IRA, you may also convert it to a Roth IRA and pay taxes on the conversion. If certain requirements are met, your beneficiaries may be able to take distributions over 10 years without paying taxes.
However, this strategy may include fees and tax implications. Consider speaking with a financial professional or tax advisor before making a decision.
Managing an Inherited IRA for the Future
Leaving loved ones a financial legacy can be very important for many parents, spouses and grandparents. Whether you intend to pass on an IRA or expect to inherit one, it can be helpful to understand how the new 10-year rule may affect you. Consider talking to the right financial professionals as you navigate these changes.
Sources
- H.R.1994 - Setting Every Community Up for Retirement Enhancement Act of 2019. https://www.congress.gov/bill/116th-congress/house-bill/1994.
