UPDATE: Under the CARES Act of 2020, the rules for distributing assets from an inherited IRA have changed.
Spouses: The only change is the age when distributions must begin. The timing of the initial distribution may be based on your spouse’s age at the time of his/her death. If your spouse was older than age 72, you must begin taking RMDs by December 31 of the year following your spouse’s death. If your spouse was younger than 72, you may be able to delay RMDs until your spouse would have turned 72.
Non-spouses: For those whom the original account owner died December 31st, 2019 or before, in addition to the option of withdrawing all money from the inherited IRA within 5 years, non-spouse beneficiaries have the option to take Required Minimum Distributions over their lifetime. Generally, the IRS requires non-spouse beneficiaries to begin taking RMDs from the inherited assets beginning in the year following the year of death of the original owner. The first RMD must be taken from the newly established Inherited IRA by December 31 of that next year. So if the original owner died in 2019, then the first RMD must be taken by December 31, 2020.
As a non-spouse beneficiary, you must directly roll over the inherited assets to an Inherited IRA in your own name and use your own age and the IRS Single Life Expectancy Table for calculating the first year RMD. For each year after, you would subtract one year from the initial life expectancy factor.
For those whom the original account owner died January 1, 2020 or after, you must directly roll over the inherited assets to an Inherited IRA and you will need to withdraw all assets from the inherited IRA within 10 years following the death of the original account holder. Exceptions to the 10-year distribution requirement applies to assets left to an eligible designated beneficiary.
Losing a loved one is always difficult and to make things tougher, some important financial decisions often need to be made soon afterwards. If you were named the beneficiary on a retirement account such as a 401(k), 403(b), or IRA you typically have a couple of options for handling this inheritance. If the decedent was a spouse, there is a wider range of options, but for now we will focus on non-spouse inherited retirement accounts.
If the decedent was under age 70 ½, you as the non-spouse beneficiary can keep the money in the existing account but must take distributions in one of two ways. You can choose to distribute the entirety of the account no later than December 31st of the fifth year following the year the account owner died. Alternatively, you can elect to distribute the account in one lump sum. In either case, you will not be charged the 10% early withdrawal penalty if you are under age 59 ½, however, you must include the distribution in your income and pay income taxes on it. Depending on the size of the account, the distribution could push you into a higher tax bracket. It’s best to consult with a tax professional to determine the appropriate distribution timeline.
Another option is to transfer the money from the decedent’s retirement account into an inherited IRA. These accounts are specifically designed for retirement accounts inherited by a non-spouse beneficiary and allow you to distribute the money based on your life expectancy instead of the decedent’s. Each year you are required to distribute a portion of the account based on the previous year-end account value and your IRS life expectancy factor. For example, if the account value was $100,000 on 12/31/18 and you turn 45 years old during 2019, you would divide $100,000 by your IRS life expectancy factor of 38.8. Your resulting Required Minimum Distribution (RMD) would be $2,578 for this year, and it must be taken by December 31st and included in your taxable income for the year. NOTE: unlike your own IRA which allows for the IRS factor to be taken from published tables, inherited IRA factors are generally calculated based on the age the beneficiary will attain the year after the original account owners death, then reduced by 1 for each subsequent year.
While you can always take out more than the RMD each year, you must take at least the calculated amount or the penalty for failing to do this is severe. You must pay a 50% tax on any amount that fell short of the RMD. It is important to remember that each year the RMD must be recalculated since the year-end account value as well as your life expectancy factor will change.
The primary benefit of taking the inherited IRA route is that you can spread the distributions over a longer period of time, leaving the remainder of the accounted invested to hopefully continue growing tax deferred.
If the decedent was over age 70½ you also have two options for distributing the account. Since they were already taking RMDs at the time of death, you can continue withdrawing the RMD based on their IRS life expectancy factor, meaning you are not forced to distribute the full amount in the 5-year window. You can take out more than the RMD but not less or else the 50% tax applies. The other option is to move the money into an inherited IRA and base the RMDs off your own IRS life expectancy factor as described above.
The rules for non-spouse inherited retirement accounts can be complex so we recommend discussing your options with your financial advisor or tax professional.
Jeff Witz, CFP® welcomes readers’ questions. He can be reached at 800-883-8555 or at email@example.com.
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