I Inherited an IRA. What’s Next?
Welcome back to Chris’ Client Corner!
There has been a lot of information coming out over the past few years regarding inherited IRAs, and some questions have finally been answered with the most recent guidance released by the IRS. Let’s look at what that means for those who have inherited IRAs recently and how they are to be handled moving forward per recent IRS guidance.
When an individual inherits an IRA from the original account owner, they must eventually take that money out of the account and pay tax on the distribution (Uncle Sam will always get what he is owed). Prior to the passing of the original SECURE Act in December 2019, most non-spouse beneficiaries were able to “stretch” out distributions over many years by using their life expectancy to take distributions from the inherited IRA over the remainder of their lifetime (referred to as the stretch rule). This helped them to spread taxation over a long period of time rather than getting hit with taxes on a large distribution all at once or within a shorter period.
With the passing of the SECURE Act came changes in the treatment of those distributions for most non-spouse beneficiaries (spouses can still use the stretch rule). It stated that these beneficiaries were subject to the 10-Year Rule, which requires them to distribute inherited retirement accounts by the end of the 10th year following the death of the account owner. The additional details regarding how to handle RMDs (Required Minimum Distributions) were not confirmed until recently.
Finally, as of July 18th, the IRS released guidance confirming the timeline that Non-Eligible Designated Beneficiaries must adhere to. For deceased IRA owners that passed away prior to their RBD (Required Beginning Date) for taking RMDs, the beneficiary must empty the account by the end of the 10th year after the owner's death. There are not any requirements for the beneficiary to make annual distributions beyond that. Those same beneficiaries who inherited and IRA from someone on or after their RBD, must not only empty the account by the end of the 10th year, but must also take RMDs annually. This will take effect in 2025, waiving the requirement for beneficiaries who fell into this category for 2021-2024. They will essentially begin taking those RMDs starting at the beginning of next year without having to make up for prior distributions.
Let’s take a look at this in a lovely graphic to help clear things up a bit:
It should also be noted that similar rules apply to inherited Roth accounts. However, because RMDs are not applicable to Roths, the only regulation is that the accounts must be emptied in their entirety by the end of the 10th year following the account owner’s death (it’s a tax-free distribution anyway).
Now, for those beneficiaries who don't have to take RMDs annually, but need to deplete the account within 10 years, I’ll leave you with something to consider. Just because you can leave the funds in there for 10 years, doesn’t mean you should. When taking funds out of a Traditional IRA (even if it is inherited) you must pay income tax on the distributions. Waiting until year 10 to do so can leave you with quite the tax bill. So, consider making distributions over that 10-year period, even if you aren't required to do so. Vanguard published a recent article that suggested taking equal distributions from an inherited IRA over a 10-year period to help lower your tax burden. While there are obviously caveats to that, it is important to understand the tax consequences of inheriting a retirement account and how that will affect your tax planning. Always consult with an accountant when making these decisions and give your trusted financial advisor a call for additional guidance.
Sources:
Liberty One Wealth Advisors is registered as an Investment Advisor with the Securities and Exchange Commission (SEC). Any opinions expressed are derived from sources generally believed to be reliable and is provided for informational purposes only. It does not constitute any form of advice or recommendation to buy or sell any securities, adopt any investment strategy discussed or invest in any specific product. Nothing contained in this newsletter constitutes investment, legal, tax or other advice and is not to be relied on in making an investment or other decision. Please contact your financial advisor if you have any questions or would like to discuss this content.