Required Minimum Distribution (RMD) Series: Inherited IRAs

August 26, 2021

U.S. citizens currently hold more than $12 trillion in individual retirement accounts (IRAs). A large portion of that IRA money will be spent by account holders during their retirement, but a sizable portion will be inherited by beneficiaries in the coming years.

What is an inherited IRA?

An inherited IRA is an individual retirement account that a beneficiary inherits upon the passing of the original owner of the IRA. The IRS has specific rules regarding the time frame in which the beneficiary must withdraw funds from the account.

If the deceased original owner of the IRA was expected to take a Required Minimum Distribution (RMD) in the year they pass away, this distribution must be taken before the beneficiary can take control of the inherited IRA.

Is a beneficiary IRA and an inherited IRA the same?

Yes. In most cases custodians and advisors use these terms interchangeably.

What are the new rules for inherited IRA distributions?

Prior to the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) in 2019, most beneficiaries were able to take the IRS mandated withdrawals over their own lifetimes. Now non-spousal beneficiaries must withdraw the entire value of the inherited IRA within 10 years after the passing of the original owner, also known as the 10-year rule.

Any non-spousal beneficiaries who do not empty the account within 10 years could be subject to a 50% penalty tax on the remainder.

What are the inherited IRA rules for non-spouses?

If the beneficiary of the IRA is a non-spouse, the IRS requires them to withdraw all money from the account by December 31st of the 10th year after the original owner was deceased. This essentially means the beneficiary has up to 11 years to deplete the account if they choose to start withdrawing money in the year of the original owner’s death.

Does an inherited IRA have to be distributed in 10 years?

Yes.  Most non-spouse beneficiaries are required to withdraw the entire account within 10 years of the original owner’s passing. Exceptions apply to spouses and certain eligible designated beneficiaries.

Certain eligible designated beneficiaries are defined by the IRS as someone who is either:

  • The original IRA owner’s minor child – Once a minor child reaches the age of majority for their state, they’ll become subject to the 10-year rule
  • An individual who is not more than 10 years year younger than the IRA owner
  • Disabled (as defined by the IRS)
  • Chronically ill (as defined by the IRS)

What are the inherited IRA rules for spouses?

If the beneficiary of the IRA is a spouse, the IRS allows them a few options regarding timing of the required minimum distributions (RMDs). The spouse can choose to do one of the following:

  • Remain a beneficiary of the IRA – The account is treated as an inherited IRA and future RMDs are calculated using the IRS Single Life Expectancy Table based on the original owner’s age
  • Become the owner of the IRA – RMDs are calculated using the IRS Single Life Expectancy Table based on the life expectancy of the spousal beneficiary and commence at age 72.
  • Roll over the money into the beneficiary’s existing IRA RMDs are calculated using the IRS Uniform Lifetime Table based on the age of the spousal beneficiary and commence at age 72.

Does an inherited IRA distribution count as income?

Yes. The beneficiary will not be taxed until they start taking withdrawals from the inherited traditional IRA. These withdrawals are usually taxed at the beneficiary’s ordinary income tax rate.

Withdrawals from inherited Roth IRAs that are older than 5 years old are not subject to income taxes.

Does an inherited IRA have to be distributed in 5 years?

There are two five-year rules when it comes to inherited IRAs:

  • No named beneficiary – if the original owner did not designate beneficiaries, the estate will need to withdraw all the money from the IRA within five years
  • A Roth IRA less than five years old – While Roth IRAs are not subject to required distributions, the earnings could be subject to tax if withdrawn prior to five years after the original owner opened the Roth IRA.

For more information about your inherited IRAs, please reach out to a Dean advisor. For over 50 years, C.H. Dean has been guiding clients and developing personalized strategies that leverage inherited IRAs to help clients achieve their financial goals. We are ready to discuss strategies that will enable you to live the life you envision.