When You Inherit an IRA
When you lose a loved one, your first thoughts probably won’t be about what to do with their IRA. But if you’re a beneficiary, it is important to make wise decisions to help avoid excess taxes and penalties. Due to changes to the beneficiary rules in the SECURE Act, the information below applies to deaths on or after January 1, 2020.
Everyone: Any beneficiary can take all the account assets as a lump-sum payment without incurring an IRS 10-percent early withdrawal penalty. However, if it’s a traditional IRA, you’ll pay income taxes on the amount distributed that has not been previously taxed. This may push you into a higher tax bracket. If the IRA owner was over the Required Minimum Distribution (RMD) age (age 72), you will need to determine whether they took their RMD for the year they died. If they didn’t, you must do so before the end of the calendar year or potentially incur a 50-percent IRS excess accumulation penalty on the RMD amount.
A surviving spouse: A surviving spouse has the most options. You can designate yourself as the owner of your spouse’s account, transfer the funds into your own IRA, or open a beneficiary (or stretch) IRA. With the latter instance, RMD amounts will be based on your age and be recalculated each year based on the factors in the IRS Single Life Expectancy Table.
Other eligible designated beneficiary: If you’re a minor, chronically ill, disabled, or fewer than 10 years younger than the deceased, you may open a beneficiary IRA and stretch the distributions described above. When minors reach the age of majority, the 10-year distribution rule applies.
Another relative or friend: If you don’t fall into the categories above and don’t choose to take a lump payment, you will need to create a beneficiary IRA account and transfer the funds. You won’t be allowed to make new contributions to the account. There are no annual required distributions, but you must distribute the balance within 10 years.
COVID exceptions: Because of COVID, all RMDs have been suspended for 2020. This waiver includes beneficiary IRAs. Consult with your tax advisor regarding the impact of COVID-related legislation on the 10-year liquidation requirement.
This brief article doesn’t cover all of the rules and options regarding inherited retirement accounts. But I would be happy to explain different possibilities and their ramifications, and work with your tax and legal professionals to help guide you through any decisions you face.
The treatment of inherited IRAs can be tricky; before you make any changes, I recommend consulting the IRS publications on this topic.
This material is intended to provide general financial education and is not written or intended as tax or legal advice and may not be relied upon for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel.