An inherited individual retirement account is created with the funds in an IRA or employer-sponsored retirement plan after the original owner passes away. You are not able to make more contributions to the account after inheriting it and will need to take distributions according to specific rules, which vary based on your age and relationship to the deceased.
Make a plan for these inherited IRA distribution rules:
— Understand how the inherited IRA 10-year rule works.
— Know what exceptions are made to the inherited IRA 10-year rule.
— Take the right steps if you are a spouse who has inherited an IRA.
— Learn how IRA beneficiary rules have changed in recent years.
— Consider how your taxes could be impacted.
What Is the Inherited IRA 10 Year Rule?
When an IRA owner passes away, the account is passed on to the named beneficiary. The inherited IRA 10-year rule refers to how those assets are handled once the IRA changes hands. For some beneficiaries, including non-spouses, all the funds must be withdrawn within 10 years of the previous owner’s passing. Spouses who inherit an IRA have other options to consider. There are also exceptions for beneficiaries who meet certain criteria. The 10-year rule applies to those who have inherited an IRA on or after January 1, 2020.
It is also possible to withdraw funds at a faster pace when you inherit an IRA. “All beneficiaries have the option to use the lump sum method,” says Aviva Pinto, a managing director at Wealthspire Advisors in New York.
[Read: How to Manage an Inherited IRA.]
Exceptions to the Inherited IRA 10 Year Rule
In some cases, the inherited IRA 10-year rule is not applied. Exceptions to the inherited IRA 10-year rule include:
— The IRA owner’s surviving spouse.
— The IRA owner’s minor child.
— An individual who is not more than 10 years younger than the IRA owner.
— A disabled or chronically ill person, as determined by the IRS.
However, once a minor child reaches the age of majority, they become subject to the 10-year rule.
Special Inherited IRA Rules for Surviving Spouses
If a spouse receives an IRA, there are different rules that apply. “If you are the primary beneficiary of your spouse’s retirement assets, you can generally treat inherited assets as if they are your own,” Pinto says. In cases in which the deceased was taking RMDs from a traditional IRA at the time of their passing, you’ll need to take the required minimum distribution during the year they pass if they have not done so already. Otherwise, you can wait until you reach the age that you need to begin taking required minimum distributions to withdraw from the account.
Alternatively, a spouse can choose to open and transfer the assets into an inherited IRA. The funds can then be withdrawn during the 10-year timeframe.
You’ll want to consider your situation if you are a spouse who inherits a retirement account. “Treating the IRA as your own is generally advised for most spouses,” Pinto says. However, if you are under age 59 1/2 and need funds from the account, you might opt to open an inherited IRA and start taking distributions. If you take distributions from your own account prior to age 59 1/2, the funds will be subject to a 10% penalty.
How the SECURE Act Changed Inherited IRA Rules
The inherited IRA 10-year rule changed the way this type of account is handled when it passes from one account holder to another. It came into effect by way of the SECURE Act, which was passed in December 2019 and became a law as of January 1, 2020. “The SECURE Act eliminated the stretch IRA for certain beneficiaries,” says Michele Lee Fine, founder and CEO of Cornerstone Wealth Advisory in Jericho, New York. “The Stretch IRA is the ability of the named beneficiary to spread (or stretch) required post-death distributions over the beneficiary’s life expectancy using the IRS single life expectancy table.”
The timing of the account owner’s passing plays a role when determining the next steps. “If an individual died in 2020 or later, then you don’t have to take RMDs, but you need to withdraw the entire amount of the IRA within 10 years,” says Jonathan Shenkman, a financial advisor and president of Shenkman Wealth Management in Woodbury, New York.
For deaths on or before December 31, 2019, the old rules for inherited IRAs remain in place. Non-spouse beneficiaries are allowed to continue the stretch provision.
Tax Considerations of the IRA 10-Year Rule
If you inherit a traditional IRA with contributions that have been made with pre-tax dollars, withdrawals are subject to taxes. Roth IRAs are funded with after-tax dollars and withdrawals are typically not subject to tax.
With inherited IRAs, you won’t face some of the same penalties that apply to other types of IRAs. For example, there is often a 10% penalty if you take a distribution from a traditional IRA before age 59 1/2, but you can withdraw money from a traditional inherited IRA prior to this age without facing a penalty.
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