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Inherited IRA Required Minimum Distribution (RMD) Rules Thumbnail

Inherited IRA Required Minimum Distribution (RMD) Rules

Whether you're navigating inheritance or planning your estate you'll want to know how the 10-year RMD rules work for inherited IRAs. Tim provides clarity on distribution timelines, tax implications, and beneficiary designations.

This article and video discuss Required Minimum Distribution (RMD) rules for an inherited IRA received from someone who passed away in or after 2020.

The rules for inherited IRAs before 2020 (before the SECURE Act) were different, but it’s been a few years so most of those inherited IRAs have already been dealt with. 

The IRS requires owners of IRAs to withdraw part of their tax-deferred savings each year, starting at age 73, or 75 if you were born in or after 1960.

However, if you inherit an IRA, there are different RMD rules for different types of beneficiaries. Why? RMDs are designed to ensure that investments in IRAs don't grow tax-deferred forever and Uncle Sam gets his pound of flesh.

The rules for how IRA beneficiaries must take RMDs will also depend on when the account owner passed away. IRA owners generally must take their first RMD by April 1 of the year after they reach age 73, or 75 if born in 1960 or later. This is called their required beginning date (RBD). 

So, again, the date of death of the original IRA owner and the type of beneficiary will determine which distribution method to use. And you must take an RMD for the year of the IRA owner's death, if the owner had an RMD obligation that wasn't satisfied. 

Types of Beneficiaries

Essentially, we have four different types of IRA beneficiaries:

  1. Spousal beneficiaries
  2. Designated beneficiaries
  3. Eligible designated beneficiaries
  4. Non-designated beneficiaries 

That's just crazy to me. I mean, “designated beneficiaries, eligible designated beneficiaries, and non-designated beneficiaries.” It just always seems like they’re trying to make it confusing. But, I don’t make the rules. Moving on...

The RMD rules are different for each of these 4 different types of beneficiaries.

Designated Beneficiaries

First, a designated beneficiary, which is a person or see-through trust. They will be subject to the 10-year rule, which states they will be required to liquidate the account by the end of the 10th year following the year of death of the original IRA owner. And, an RMD is required in years 1-9 if the original owner had already begun taking RMDs.

So, this means that if they died before their RMD age, the beneficiary can withdraw any amount at any time, as long as they withdraw the entire amount in the 10 years following the death of the original owner. But if RMDs had already started, then the beneficiary will have to take RMDs based on their own life expectancy, but then in year 10, they will have to withdraw any remaining amounts.

And unfortunately, as I’ve mentioned in other videos, this can cause a tax bomb for beneficiaries because they will likely inherit this money in their peak earning years and will have to stack this ordinary income on top of their own ordinary income, which causes them to pay higher taxes than before the SECURE Act when they could have used the stretch IRA to make relatively low RMDs over their life expectancy, instead of having to take it all within 10 years. 

Eligible Designated Beneficiaries

Next, eligible designated beneficiaries are exempt from the 10-year rule. Eligible designated beneficiaries are

  1. Spouse
  2. Children under the age of 21
  3. Individuals not more than 10 years younger than the IRA owner
  4. Disabled or chronically ill 

These beneficiaries can still take distributions over their lifetime following the old rules prior to the SECURE Act. However, once a minor child reaches the age of majority (21), they'll become subject to the 10-year rule. So, they basically go from an eligible designated beneficiary to a designated beneficiary. 

Surviving Spouses

Next, surviving spouses have additional options: they can create an inherited IRA and might be able to use the original account holder’s RMD age to begin taking RMDs based on their own life expectancy. You might want to do this if you are under the age 59.5 because you won’t have to pay a penalty. 

They can also roll the account over into their own IRA. No other beneficiary has that option.

Non-designated Beneficiaries

Next, a non-designated beneficiary is a nonperson entity such as an estate, a charity, or a trust that is not a see-through trust. A non-designated beneficiary would have up to 5 years to withdraw the balance of an IRA if the IRA owner was under the age at which RMDs are required. If the IRA owner was over age 73 or 75, the non-designated beneficiary may continue to take out the RMDs over what would have been the IRA owner’s remaining life expectancy. This allows the most funds to continue to grow tax-deferred.

Roth IRA Differences

Roth IRAs are obviously also individual retirement accounts, so they are also subject to the 10-year rule. However, no RMDs are required for a Roth IRA, but you will still have to fully liquidate the account by the end of the 10 years after death

Since there are no taxes payable on this money, you will want to leave it in the Roth IRA as long as possible and have it (hopefully) grow, and receive more money tax-free. 

5-Year Rule for Roth IRAs

A Roth IRA has a 5-year waiting period after the first contribution before the earnings can be withdrawn tax-free (assuming you have reached age 59 ½). Reminder: You can always withdraw your own contributions from a Roth IRA anytime without penalty. The 5-year period starts January 1 of the year the first contribution was made.

This 5-year rule also comes into play when inheriting a Roth IRA. If the IRA owner dies before the Roth IRA has been opened for 5 years, any earnings withdrawn before the 5-year rule is satisfied will be subject to income tax. 

Bottom Line 

If you’re inheriting an IRA, be sure to check and double-check to ensure you are handling it correctly because as you probably already know, it’s easy to make mistakes with our convoluted tax code. And you need to pay attention to the type of beneficiary you are as well as how and when you receive assets because it can have large implications on your lifetime tax liabilities.

A CERTIFIED financial planner™ professional can help you plan for your retirement. Schedule a call today so we can talk about your situation. 

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