Inheriting an Individual Retirement Arrangement (IRA) account used to be a straightforward process, but changes in tax laws outlined in the SECURE Act of 2019 have brought some important modifications, especially for “non-spousal” beneficiaries. If you've inherited an IRA or a Roth IRA or you're planning for your beneficiaries, it's crucial to understand the new rules.
What's an Inherited IRA or Inherited Roth IRA?
Before diving into the new rules, let's clarify what an Inherited IRA and an Inherited Roth IRA are.
Inheriting an IRA or Roth IRA means you were named as a beneficiary on the account of a deceased relative or friend. The difference between the two is in the tax obligation of withdrawals. Inheriting an IRA means you'll have to follow specific rules regarding withdrawals, contributions, and taxes.
New Rule #1: The 10-Year Rule
One significant change applies to both Inherited IRAs and Inherited Roth IRAs. Under the new rules, most non-spouse heirs are required to withdraw all the funds from the inherited account within ten years following the date of death. This rule is known as the "10-Year Rule" and applies to accounts where the owner died after 12/31/2019. Those who died before that date are “grandfathered” into the previous rules, as being able to “stretch” distribution over the heir's life expectancy, in most cases.
New Rule #2: RMD’s on Inherited IRAs
There has been some confusion around the implementation of this rule for those who have inherited IRAs for which the original account owner was already taking Required Minimum Distributions. Most people originally interpreted the rule to mean that heirs have the flexibility to choose how much and when to take distributions as long as the account is depleted in 10 years. But in 2022, the Treasury Department proposed regulations stating that if the account owner died after reaching their required beginning date (the date on which they had to begin taking their required minimum distributions, or RMD) the heir would be required to take at least the minimum distributions based on their life expectancy for the first nine years and a full distribution by the end of year 10. Since the final status of these regulations is still pending, the IRS has waived penalties for heirs who did not take an RMD in 2021 or 2022 and recently extended this courtesy into 2023. Inheritors should be aware that this may change as soon as 2024. In the meantime, IRA heirs can still take a “lump sum” distribution from an Inherited Traditional IRA and pay tax on the entire amount (this is not applicable to an Inherited Roth IRA since there are no tax consequences when withdrawals are taken).
Exceptions to the 10-Year Rule
There are a few exceptions to the 10-Year Rule:
- Spousal Beneficiaries: Surviving spouses can still roll over an Inherited IRA into their own IRA and continue to enjoy the tax benefits. They're not subject to the 10-Year Rule.
- Minor Children: If you inherit an IRA as a minor child, you must start taking distributions once you reach the age of majority. This means you can potentially stretch the distributions over a more extended period.
- Disabled or Chronically Ill Beneficiaries: Beneficiaries with disabilities or who are chronically ill may be exempt from the 10-Year Rule and can take distributions based on their life expectancy.
- Beneficiaries within ten years of the account owner's age: These beneficiaries may continue using the previous rules and stretch the distributions over their life expectancy.
Roth IRAs have always had some unique tax advantages. Under the new rules, if you inherit a Roth IRA, you'll be pleased to know that qualified distributions remain tax-free. However, you're still subject to the 10-Year Rule, which means you must withdraw all the money within ten years.
Planning for the Future
The new rules for Inherited IRAs and Inherited Roth IRAs underscore the importance of careful financial planning. Here are a few tips to consider:
- Understand the Rules: Make sure you're aware of the specific rules that apply to your situation and seek advice from your financial advisor.
- Beneficiary Designations: Keep your beneficiary designations up-to-date. Review and update them regularly to ensure your assets go to the right people.
- Tax Implications: Consult with a tax professional to understand how these rules may affect your overall financial plan.
- Consider Estate Planning: If you have a significant amount in your retirement account, consider discussing estate planning strategies with an attorney to maximize your legacy.
The new rules for Inherited IRAs and Inherited Roth IRAs emphasize the need for careful planning and staying informed about your financial options. Whether you're the beneficiary or the account holder, understanding these rules will help you make the most of your retirement savings and ensure a smooth transition for your loved ones.
*The foregoing content reflects the opinions of Van Hulzen Asset Management DBA "Van Hulzen Financial Advisors" and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.