Navigating the Latest Distribution Rules for Inherited IRAs

Few financial instruments carry as much significance as Inherited Individual Retirement Accounts (IRAs). These accounts passed down from generation to generation have long been essential for legacy planning. 

However, the SECURE Act has made changes that have reshaped the landscape for those inheriting IRAs after 12/31/2019. These changes affect how beneficiaries access and manage these assets, requiring a fresh plan and perspective on planning strategies. 

In this blog, we’re diving into the latest rules for Inherited IRAs and exploring updated strategies in light of these changes.

Types of Inherited IRAs

Before discussing the changes to the SECURE Act, let’s first run through the different types of Inherited IRAs. 

First up is the Pre-Tax Inherited IRA. As the name implies, these are inherited from someone who had a pre-tax retirement account, such as a Traditional, Rollover, SEP, 401(k), 403(b) or SIMPLE IRA. The distributions from a Pre-Tax Inherited IRA are typically subject to income tax. 

Similarly, a Roth Inherited IRA is inherited from individuals with a Roth IRA or after-tax retirement plans. Distributions from an Inherited Roth IRA are generally tax-free. 

Another important topic to understand is the difference between spousal vs. non-spousal inheritance. There are different rules for spouse and non-spousal beneficiaries (such as children or siblings). These changes mostly fall around the distribution options, which we will discuss later in this blog.

Fundamental Changes in the SECURE Act

The SECURE Act was enacted in December 2019 and substantially revised the rules regarding Inherited IRAs. The very popular “stretch IRA” has been eliminated in most circumstances and replaced with a more finite 10-year window. 

Before the SECURE Act, non-spousal beneficiaries had the option to “stretch” distributions from an Inherited IRA over their life expectancy, which allowed for a more extended period of tax-advantaged growth. This strategy is now essentially a thing of the past because, in most cases, the SECURE Act mandates that beneficiaries fully deplete the Inherited IRA within ten years of the original account owner’s death. However, beneficiaries may have flexibility in managing their distributions within this 10-year timeframe, allowing them to tailor their distribution strategy to their financial needs and tax considerations. 

Like most rules, there are special considerations and exemptions. The SECURE Act is no different. Eligible designated beneficiaries: Certain individuals are exempt from the 10-year rule. This includes surviving spouses, minor children of the account owner (until they reach the age of majority), disabled individuals, chronically ill individuals, and beneficiaries not more than ten years younger than the original account owner.

Required Minimum Distributions (RMDs)

RMDs are mandatory withdrawals that individuals with tax-advantaged retirement accounts (like IRAs) must take once they reach a certain age. The purpose of RMDs is to ensure that individuals draw down their retirement savings and pay taxes on those distributions during their retirement years.

In 2024, the age for required minimum distributions is 73. In 2033, the age jumps to 75.

So, what do RMDs have to do with Inherited IRAs? The rules regarding RMDs for Inherited IRAs significantly transformed under the SECURE Act. As mentioned earlier, non-spouse beneficiaries must now deplete the Inherited IRA within ten years of the original account owner’s death and may have to take a calculated annual distribution during the 10-year span.

Try Schwab’s calculator to determine your RMD on an inherited retirement account under the new rules.

Beneficiaries must diligently track RMD deadlines and withdraw the appropriate amount within the specified time frame to avoid penalties. For inherited IRAs, the penalty for failing to take the RMD within ten years is up to 25% of the amount that should have been withdrawn. This penalty is applied to the shortfall between the actual distribution and the required amount. 

Options for Spousal vs. Non-Spousal Beneficiaries

The choices available to beneficiaries vary significantly based on their relationship to the original account holder. Let’s examine a few critical differences between spousal and non-spousal beneficiaries. 

Spousal beneficiaries:

Option to treat as own: Spousal beneficiaries can treat the Inherited IRA account as their own, which potentially allows them to further delay the start of RMDs if they haven’t reached RMD age, plus, spouses can stretch the RMD over their lifetime vs the 10-year period. However, spouses can always choose to take more than what’s required, thereby accelerating the distribution schedule if needed.

Non-spousal beneficiaries:

If the original account owner died prior to having reached RMD age, the non-spouse beneficiary may take withdrawals as slowly or as quickly as they wish provided all funds are withdrawn by the end of the tenth year following the year of the IRA owner’s death. There is no schedule for how payments must come out, but the entire IRA must be depleted by December 31 of the tenth year.

If the original account owner had already begun RMDs, the beneficiary must withdraw their own RMD amount each year beginning in the calendar year following the year of the IRA owner’s death. The annual distribution is generally based on the beneficiary’s single life expectancy, non-recalculated. And if the original owner didn’t take their RMD in the year of passing, it must be taken by the beneficiary. In addition to taking the required minimum, the entire Inherited IRA must be depleted no later than December 31 of the tenth year following the IRA owner’s year of death. 

As you can see, there is some flexibility in how to take payments. You can take more than what’s required, but it’s imperative to understand if you have any required minimums to meet on an annual basis, and how delaying distributions may impact your taxes in future years when the balance must be distributed in full. For instance, maybe taking a lump distribution in any one year (early on, middle or end) makes the most sense if you have unstable or erratic income. Taking advantage of a low-income year by maximizing your distribution could be a wise choice. But maybe you’re in the middle of your career and you expect stable income. Deciding on a more evenly divided distribution could make the most sense. Careful consideration of tax brackets, other sources of income, and individual financial goals can guide the timing and amount of withdrawals. 

Navigating Tax Implications

Understanding the tax implications of inherited IRAs is essential for beneficiaries seeking to maximize the benefits of their inheritance while staying tax-compliant. 

Let’s examine how inherited IRAs are treated regarding tax purposes and how beneficiaries can mitigate their impact. 

  • Traditional inherited IRA: Generally treated as ordinary income for tax purposes. This means the amount withdrawn is subject to income tax at the recipient’s marginal tax rate.
  • Roth inherited IRA: Distributions from a Roth inherited IRA are typically tax-free as long as the Roth IRA was established for at least five years before the first distribution. 
  • Distributions: Withdrawals from a traditional inherited IRA increase the recipient’s taxable income for the year the distribution occurs. The larger the distribution, the higher the impact on the overall tax liability. Not only could this impact federal and state tax liability, but it could also trigger high IRMAA brackets. IRMAA brackets dictate any potential monthly surcharges that increase Medicare B and D premiums.
  • RMDs: These must be factored into the beneficiary’s tax planning. The amount of RMD is treated as ordinary income for tax purposes and may push the beneficiary into a higher tax bracket.
  • State income tax: State regulations vary, so beneficiaries must know how inherited IRA distributions are treated in their state. For example, some states may have different tax rates or exemptions for retirement income. 
  • Inheritance and estate tax: Some states also impose inheritance or estate taxes, which can affect the overall taxation of the inherited assets. 

Beneficiaries can strategically time their withdrawals to help mitigate the tax impact on inherited IRAs. For example, spreading distributions over several years may help avoid moving into a higher tax bracket. And this is important to keep in mind given the IRS has allowed RMD beneficiaries to waive 2024 distribution requirements given how complicated the new rules are. However, paying the tax on RMDs is not an “if” but a “when,” so delaying will only leave more to be distributed over a shorter period. 

In addition, in certain situations, beneficiaries may explore converting a traditional inherited IRA into a Roth IRA. This conversion can have tax implications but may benefit those looking to manage tax liability over the long term. 

Managing inherited assets requires careful consideration of individual financial goals, tax efficiency, and compliance with state regulations. Whether you’re a beneficiary or an individual planning your estate plan, seeking professional guidance can be crucial. Financial advisors and tax professionals can provide valuable insight and help tailor strategies custom-aligned to your unique circumstances. 

As you manage Inherited IRAs, remember that informed decision-making and strategic planning pave the way for preserving wealth and ensuring a legacy that stands the test of time. 


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